Valuations, Promising Future Prospects Form Basis Of Bullish Stance On ConAgra Foods

Dec.24.13 | About: ConAgra Foods, (CAG)

ConAgra Foods (NYSE:CAG) is among the leading food companies of North America, and has been delivering satisfactory financial performance in recent times. I remain bullish on the stock, as the company reported solid 2QFY2014 financial results, has been expanding its Private label operations, has attractive valuations, and offers a potential total return of 20%. Also, the company recently indicated that it expects to derive incremental productivity savings, which will fuel its bottom line growth.

Financial Performance

CAG reported better-than-expected financial performance for 2QFY2014, mainly driven by an improving sales volume, a better consumer spending trend and the inclusion of financial results of Ralcorp foodservice business. The company reported net revenues of $4.71 billion, beating consensus estimates of $4.6 billion, up 26.5% as compared to the corresponding period last year. Adjusted EPS for the last quarter came out to be $0.62, up from $0.57 in 2QFY2013.

The company's Consumer Foods segment, which contributes approximately 42% towards total revenues, experienced an operating profit increase of 13% year-on-year and flat net revenues in the recent quarter. Foreign currency movements had a negative 1% impact on the segment's top line results. The segment's profit was positively affected by strong efficiencies related to selling, general and administration (SG&A) expenses, and supply chain productivity measures. CAG's Private Brands segment reported net revenues of $1.1 billion for 2QFY2014, up from $900 million in the comparable quarter last year. Results for the segment were positively affected by the acquisition of Ralcorp businesses.

CAG's Commercial Foods segment, which comprises 34% of the company's total revenues, enjoyed an increase of 3% year-on-year in its revenues. Despite a decent increase in net revenues, adjusted operating profit decreased by 9% year-on-year in 2QFY2014.

Stock Price Catalysts

The company has been making efforts to expand and strengthen its Private Brands segment. In the recent quarter, the company combined all the operations of its private labels, including legacy CAG and Ralcorp, into one segment. The new combined structure of the private brands will help the company focus more on private brands and better serve its customers. Also, the initiative will help the company grow in the private label brand market. Currently, the Private Brands segment comprises 22% of the company's total revenues; the ratio is expected to grow in the future as the company continues to aggressively work towards expanding its private label business.

The improving sales trend for the company's Consumer segment is another important stock price driver. Organic sales growth for the segment was flat, better than a 3% decline in 1QFY2014, indicating sequential improvement in the segment's performance. Also, the company indicated during the recent earnings call that the consumer trend had been improving, as it had a good Thanksgiving period. Also, as consumer spending is expected to improve in the U.S. and other important economies, it will benefit CAG's financial performance as we move forward.

Another important earnings growth driver for the company remains SG&A and productivity savings. As the company is expected to target double digit earnings growth in the next fiscal year, FY2015, costs saving initiatives remain important. Recently, the company indicated that in addition to the previous Ralcorp integration efforts, it foresees additional opportunities to improve productivity and reduce cost structures across all segments. Previously, the company has approved $200 million of restructuring costs in relation to the Ralcorp integration. The company might announce additional restructuring, as we move forward, which will have a positive impact on the company's earnings and the stock price.

Risks

The company continues to face problems in its Commercial Foods segment, as profits deteriorate. Profit for the segment was down 9% year-on-year in the recent quarter. CAG lost a major Lamb Weston customer and faces quality issues with the new potato crop. Also, due to the prevailing headwinds (including foreign currency movements), the company is expected to realize slower growth in Asia.

Moreover, last week the Superior Court of California named CAG as a defendant by issuing a decision on a 13-year old case. The decision asked for the creation of a $1.1 billion abatement fund, liability split between NL industries (NYSE:NL), Sherwin-Williams (NYSE:SHW) and CAG. CAG can object to the ruling within 15 days. The risk of a cash outflow for the fund creation might prove a near term overhang for the stock price.

Conclusion

The company has delivered strong financial performance in the recent quarter. Improving Consumer segment sales trend, growing Private Brands operations and potential cost reduction initiatives portend well for the stock's future financial performance. Also, current valuations remain attractive for CAG in comparison to its competitors. CAG currently has a cheap forward P/E of 12.9x, in comparison to its peers' average of 15.2x. Also, CAG has a lower PEG of 1.6, which reflects that the company offers cheap growth, as compared to its peers' average of 2.3. Moreover, analysts have projected a high next five years growth rate of 8.7% per annum for CAG, better than its peers, as shown in the table below. Furthermore, the stock offers a potential total return of 20%; potential price appreciation of 17% and a dividend yield of 3%, based on my price target of $39.5. I calculated the price target of $39.5 using the peers' average forward P/E of 15.2x and FY2015 EPS estimates of $2.59. Due to the aforementioned factors, I have a bullish stance on the stock.

CAG

General Mills (NYSE:GIS)

Kraft Foods (KRFT)

Kellogg (NYSE:K)

Average

Forward P/E

12.9x

15.85x

17x

15x

15.2x

PEG

1.6

2.2

3

2.3

2.3

Next 5-Year Growth Rate

8.7%

7.8%

6.4%

7%

7.5%

Click to enlarge

Source: Yahoofinance.com

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.