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ConAgra (CAG) reported its May quarter adjusted EPS surged 18% and beat the Street's forecast by a penny. In doing so, the company overcame the loss of some important business. Adding to the stock's push today, ConAgra also raised its long-term guidance for the next several fiscal years on greater than initially anticipated cost savings from its Ralcorp investment. The stock surged nearly 6% in early morning trade on the improvement, but where is it going from here? There are some issues of concern, so despite a valuation that appears attractive, my enthusiasm is tempered.

Operating Performance

ConAgra posted sales that were 33.7% greater than the prior year in its fiscal fourth quarter. Those of course benefited from the addition of $962 million in sales from the acquired Ralcorp businesses. Otherwise, the company saw a 7% sales increase from its Consumer Foods Segment and a 3.5% increase from its Commercial Foods Segment. Consumer Foods saw 3% organic volume growth, and benefited 5% from acquired business - these outweighed the unfavorable (1%) impact from price/mix factors. The company lapped important price increases taken last fiscal year in the quarter. ConAgra's Commercial Foods Segment had a setback as its Lamb Weston potato operations lost the business of a major food service customer. While the company expects to gradually replace the lost sales, it will cost FY 2014 by $0.06 to $0.07.

Operating margins expanded across segments, with no comparison offered for Ralcorp, but the Commercial Foods issue will impact its margin in FY 14. Still, for the reported quarter, operating profit increased by 36.1%, greater than the sales increase, reflecting operating margin expansion of two-tenths of a percent. The Consumer Foods Segment operating profit margin expanded by one-tenth of a percent while Commercial Foods saw a full percentage point expansion on good performing flour milling operations.

ConAgra posted EPS growth of 18% on a comparable basis. Fourth quarter EPS reached $0.60 a share, beating the analysts' consensus estimate for $0.59, even despite the Commercial Foods issue. Then the company raised its long-term guidance, setting the stage for the stock's climb today. The company said that it now expects to glean $300 million in cost related synergies from the Ralcorp acquisition, versus the previously estimated $225 million. Management expects FY 14 EPS of $2.40, but that is eight cents short of the analysts' consensus estimate for $2.48, according to Yahoo Finance data. In raising long-term guidance, the company seems to have effectively redirected attention away from this.

Despite offering FY 14 EPS guidance short of the Street view, the company raised its expectations for growth over the three years that will follow it (FY 2015 - 2017). ConAgra now sees average annual EPS growth of at least 10% through the period due in large part to synergies gained from the Ralcorp deal. What you did not notice was that the company severely cut expectations for the coming FY Q1 ending in August to approximately what it earned last year.

Chart forConAgra Foods, Inc. Chart at Yahoo Finance

The stock chart seems to reflect investor concern for the shares heading into the report, so the day's gain simply takes it to its recent 52-week high. Perhaps investors were worried about uncertainties around the Ralcorp deal or other issues, and those were resolved today.

Moving forward, I still find reason to worry here, because the loss of one customer and reported softness in the "key Asian market" could have a basis relevant to other business in the region. It will lead analysts to reduce fiscal 2014 EPS estimates, with the consensus estimate now set too high at $2.48. While ConAgra reassures that it will gradually replace the business, and provide long-term growth guidance that is appealing and supportive today, we have to get there first. In the meantime, weighty analyst earnings cuts are coming. Also, restructuring costs are ahead of us, and while the company says they will not impact its capital plans to repay some debt and grow its business, not to mention pay its dividend, there is risk. The posted gains in margins were value-added and noteworthy in the latest quarter, but the stock may be fully valued here considering the outlined issues and questions that the market has today brushed off. For ConAgra to win more support from this author, I would have to see swift replacement of the lost potato business, which would reassure me that there is not necessarily a more critical issue at play. Also, no restructuring surprises should arise.

Comparing ConAgra to peers using data from Yahoo Finance, it does not appear expensive to me on a PEG or price-to-sales basis.

Company

P/E Trailing

PEG

P/S

ConAgra

29.3

1.3

1.0

Hillshire Brands (HSH)

5.0

2.1

1.0

Kraft (KRFT)

20.5

3.2

1.75

Nestle (OTCPK:NSRGY)

18.4

3.6

2.1

Danone (OTCQX:DANOY)

20.8

3.5

1.6

The stock trades at 14.6X its guidance for EPS of $2.40 in fiscal 2014. That represents about 11.1% growth over FY 13 diluted EPS adjusted for items impacting comparability of $2.16. Add to that the 2.9% dividend yield, and we can use a 14 denominator for a PEG ratio of 1.04. Assuming it can grow at that same rate over the next five years, the stock is not expensive. However, the company says it can achieve EPS of at least $3.00 in FY 2017, four years from FY 13 (EPS of $2.16). So an 8.6% average growth rate should be assumed long-term to get there. Add to that the 2.9% dividend yield (11.5 denominator), and I get an adjusted PEG of 1.27X. That is still not bad relatively speaking. However, given the issues and concerns outlined for the near-term, and the day's already achieved recovery, I would only be willing to hold ConAgra here, and would not suggest buying it. Furthermore, if the stock were to rise much further (to say $41.40), with a PEG of 1.5X, I would sell it.

Source: ConAgra EPS Beats Street But Don't Buy It