Campbell Soup: How To Identify A Post-Earnings Recovery

| About: Campbell Soup (CPB)

After Campbell Soup (NYSE:CPB) experienced a nasty tumble following its November earnings report, I took a look at the stock as a potential buy for a post-earnings recovery. After reviewing the numbers, I concluded the stock was too expensive to warrant the risk. With some regret for dropping CPB from my radar, sprinkled with a generous helping of hindsight, I have learned some lessons about missing a post-earnings recovery. As it turned out, CPB made a perfect bottom after its post-earnings collapse and went on to print two buyable rallies. After reporting earnings on February 14th that reaffirmed guidance, CPB has printed a healthy 12% gain in just three months. This compares favorably to the S&P 500′s 3.2% gain over the same timeframe.

Using the following chart, I outline the catalysts that formed the post-earnings recovery and rally. These points provide one framework for understanding the clues that form a potentially good post-earnings recovery trade.

Campbell Soup recovers smartly from November's post-earnings collapse


Downgrade by major analyst fails to cause additional losses
Ironically, the biggest signal of a likely bottom came within days of my ill-timed piece on CPB. On November 25th, Goldman Sachs (GS) downgraded CPB to neutral. The stock reversed a small two-day gain in response, but it never closed at a new post-earnings low. Maybe a subsequent initiation of coverage by RBC Capital Markets with a $41 price target saved the day. Either way, the on-going stabilization of the stock was a prime positive signal.

Large options activity succeeds in moving the stock
Unusual options activity often turns into a false alarm. When this action DOES manage to move the underlying stock, traders and investors should pay close attention. On Friday, December 6th, trading volume in call options on CPB surged at an unusual pace. Around 46,000 contracts exchanged hands that day with a focus on the December $43 calls expiring in just two weeks.

As it turned out, that flurry of activity capped the end of sharp 4-day rally that quickly closed the post-earnings gap down, but it provided the next signal that CPB had bottomed. For whatever reason, CPB had recaptured the attention of buyers. Even if you missed the excitement, two pullbacks provided additional opportunities to get into CPB (or double down if you were unlucky enough to get caught up in the initial run-up).

M&A rumors succeed in moving the stock
I never recommend buying into rumors. However, if M&A rumors surface within a larger bullish context (or even better, a good technical setup), I am all ears. Fortuitously timed to give December's call buyers one last shot at profits, Bloomberg published an article on December 17th speculating on the possibility that Berkshire Hathaway (BRKB) might look to nab CPB. A deal seemed sufficiently plausible given Berkshire's earlier acquisition of Heinz. CPB closed up 4.3% that day, seemingly justifying the earlier call-buying. With no deal by the end of the week, and no renewed frenzy, CPB drifted lower over the next 5 weeks. The market's short attention span sapped the stock of its upward momentum. Still, the stock action did not invalidate the logic of a deal, so it is easy to foresee that subsequent M&A rumors in the future which could at least help to prop up the stock. Either way, the M&A possibilities put CPB solidly on the radar of buyers.

"Surviving" the earnings confrontation following a disaster
Buying into CPB ahead of its February earnings could have been justified by all of the above signals. On February 3rd, CPB took a sharp tumble yet sellers failed to follow-through. This was one last signal for buying CPB at cheaper prices. CPB reported earnings on February 14 and reaffirmed guidance. The company identified the problems of the previous quarter as derived from "unusual factors" which have either reversed or will get resolved in the next few quarters. Here is how Denise Morrison, President, Chief Executive Officer, and Director summarized the situation (from the Seeking Alpha transcript):

"…the first quarter inventory headwind reversed much as we anticipated. The Plum recall is behind us. We feel good that we will obtain a return on the step that advertising. Our core business however remains a bit behind our expectations for the first-half of the year for the reasons I just enumerated. So looking at the first-half, it was a tale of two cities. We got off to a slow start but recovered in the second quarter as we said we would. In the first-half, net sales from continuing operations increased 2%, adjusted EBIT declined 5% and adjusted EPS decreased 4%.

While we made substantial progress in the second quarter, we didn't expect to make up all the growth that we lost in the first quarter. We recognize that we must deliver strong results in the second-half to achieve our full-year guidance. In the second-half, we expect to grow organic sales by around 2% and acquisitions should contribute about 3% to our sales growth. For the full-year, the extra week in the fiscal year will largely be offset by currency."

This reassurance was enough to grant CPB a 5% one-day gain. The stock now sits on what I believe is support at its 200-day moving average (DMA). While I would still prefer to buy CPB at a discount (who wouldn't, right?), I think the reaction to the latest earnings report confirms that CPB has left November's disaster behind.

Since the CPB miss, I have written on other post-earnings recoveries that have worked out. So, I have learned some lessons along the way. The main logic I use is as follows: in a bull market, and especially in an economy with positive momentum, companies with solid businesses but a stroke of "bad luck" or otherwise mistimed fortune, present discounted opportunities to play future price appreciation in the general stock market. If the stock market continues higher, a post-earnings recovery should deliver out-performance. If the general stock market takes a tumble, there is (hopefully) a good chance that the recovery stock already has bad news priced into it as a buffer for the pullback.

CPB appears poised for further gains, and I have placed it firmly back on my radar.

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CPB over 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.