ConAgra Foods (NYSE:CAG) surprised the market on Wednesday with a big profit warning which send shares tumbling as a result.
Disappointing developments at the Consumer Foods business as well as Private Brands prompted the company warn about its earnings, after taking a huge amortization charge related to last year's Ralcorp deal.
The Profit Warning
ConAgra warned the market that the company's fourth quarter results will disappoint.
The company anticipates to report non-GAAP earnings of $0.55 per share which compares to the previous guidance of earnings just ahead of $0.60 per share. Analysts were looking for adjusted earnings of $0.62 per share.
The reason for the earnings shortfall is the 7% quarterly volume decline of the Consumers Foods segment as well as weak profits at the Private Brands segment.
Warning Has Consequences
As a result of the disappointing developments, the company is forced to take a large impairment charge which will result in anticipated losses of $0.76 per share for the final quarter. This is driven by a very sizable $681 million impairment charge, which fortunately is a non-cash item. If the entire impairment charge relates to the $4.95 billion equity portion of the Ralcorp deal, this means that the company admits that it paid 16% too much for the equity of the company.
The company is already addressing the performance shortfall improving the product and promotion mix in the Consumer Foods business which should drive incremental volumes in 2015. Initiatives to improve profit margins at the Private Brands segments have been started as well.
Despite the moves and initiatives, operating earnings of Private Brands are seen down by $60 million year-on-year. Besides price concessions, higher than expected costs from the integration and transition hurt as well.
The company stresses that debt reduction targets for 2014 are ahead of planning.
ConAgra Remains Long Term Optimistic
Given the outlined challenges, ConAgra expects 2015 to become a stabilization and recovery year while it should be able to deliver mid-single digit comparable earnings per share growth.
Comparable earnings per share growth in both 2016 and 2017 is seen in the high single digits driven by productivity savings and synergies resulting from the Ralcorp deal.
Valuation Of ConAgra
ConAgra is scheduled to release its definitive fourth quarter results on the 26th of June. The company ended its third quarter with $239 million in cash and equivalents and a very sizable $9.49 billion in total debt. This results in a net debt position of about $9.25 billion.
Trading at $30.50 per share, equity in the business is valued at $12.8 billion. On a trailing basis, ConAgra posted revenues of 17.9 billion on which it posted net earnings of $820 million. This values equity at just 0.7 times sales and 15-16 times earnings. Of course GAAP earnings for 2014 will be much lower due to the massive impairment charge.
ConAgra's quarterly dividend of $0.25 per share provides investors with a 3.3% dividend yield.
The main troubles appear to be resulting from the in 2012 announced acquisition of Ralcorp in an effort to boost private label sales. The $6.8 billion deal was closed at the start of 2013.
The fact that operating earnings in private brands are down $60 million in the quarter might be the big driver behind the $681 million impairment charge. Little after a year following the deal closure, this suggests that ConAgra did indeed overpay for Ralcorp.
Takeaway For Investors
Investors in ConAgra are not pleased with the too expensive Ralcorp deal in hindsight. Higher costs and a more difficult integration trajectory are impacting margins, while sales of consumer brands like Chef Boyardee and Healthy Choice are hurting the business as well.
The valuation at 15-16 times earnings appears fair, but don't forget that on a real GAAP basis, earnings will largely vanish this year. On top of that is the relatively steep debt position, which is not an imminent threat but limits flexibility of the firm. Further accretive deals are not likely without an equity issue while leverage ratio's could still increase if profitability continues to be under pressure.
I continue to shun the shares.
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