News and Background
Last year diversified food products company ConAgra Foods, Inc. (NYSE:CAG) gobbled up Ralcorp Holdings and the consensus view today is that it "bit off more than it could chew." The deal came hot on the heels of ConAgra's acquisitions of P.F. Chang's and Bertolli from Unilever in 2012. Despite the consequent indigestion, ConAgra has hardly been abstemious this year: it just merged its flour milling operations with those of Cargill and CHS to form Ardent Mills in Denver and went to China to acquire TaiMei Potato Industry Limited to fuel its Lamb Weston unit's expansion and penetration in Asian Markets.
The fact that ConAgra is headquartered in Omaha, Nebraska, says something about the company as Nebraska is both cattle country and a major producer of wheat. In fact, the roots of ConAgra lie in the Nebraska flour milling industry.
By way of its mid-tier brands ConAgra feeds blue collar America and the agricultural and industrial Heartland. However, recent acquisitions suggest that executives are evidently seeking to enlarge the company's consumer base vertically. Under CEO Gary M. Rodkin, ConAgra has tried to stretch its reach into the higher-end food market with its Bertolli and P.F. Chang's acquisitions. This is of a piece with the Ralcorp deal which would seek to strengthen the company in club stores and hypermarts where shoppers on tight budgets seek out private label offerings.
Ralcorp's Impact on the Financials
In the face of the company's well-known declines in sales and volumes of a few core brands, such as Chef Boyardee, its acquisitions that demographically, economically, and geographically broaden its consumer reach seem to make sense. However, it ran into equally well-known difficulties with Ralcorp, forcing Rodkin to implicitly admit a mistake. This admission was to the tune of impairment charges in June of $681 million of which $605 million was attributed to its Ralcorp acquisition. That $605 million writedown is on an acquisition of $5 billion. So ConAgra says that it overpaid by 13.8%. While that's not exactly sharp business, it's not 'theres-one-born-every-minute' either.
Those declining sales and volumes hitched to increases in operating and other expenses after the absorption of Ralcorp have made a mess of ConAgra's MRQ income statement. As opposed to its bleeding income statement, ConAgra's balance sheet has been very stable over five successive quarters. Only three relatively 'minor' line items show significant fluctuations. The literal bottom line has been remarkably consistent with only a slight downtick in the most-recent quarter.
The negative net change in cash, down $56.1 million QoQ, at -$800,000 is a literal 'red flag.' But note that the officers recommended and the boardroom approved $420.9 million towards dividends - an increase of 33.44% from the previous quarter. Allocating $400 million to dividends would have resulted in a comfortable net change in cash of $20.1 million but that was not considered necessary. Clearly the company itself is not overly concerned about its cash flow situation; if cash were drying up either the officers or at least the directors would not have been quite so generous.
Product Portfolio: Hold or Discard?
Apparently, as a direct consequence of its ugly quarterly results and negative EPS, some analysts are calling for ConAgra to sell off some brands. "Selling some assets and buying some stock back seems to make phenomenal sense from a shareholder value creation standpoint," was one analyst's opinion while another proposed that some slow-moving brands, like Hebrew National and Wolf Chili, could be parcelled off to pay down debt.
In response, Rodkin - though he identified Healthy Choice and a few other brands as contributing to disappointing results - stood by the company's product portfolio but didn't say a spinoff is out of the question.
Wall Street fixes are usually proposed by people with short-term outlooks who love quarterly gains and fast profits; corporate CEOs of well-run companies have somewhat longer-term horizons. Rodkin should be commended for sticking to his guns and not being buffaloed into selling off some brand.
First, sometimes one misses the point that a particular brand's low profit margins are exactly that. They are not negative profit margins, that is, the particular brand is not running a loss. If a diversified foods company has well-integrated brands that are good portfolio fits, there is no reason to suddenly press the eject button mid-tune.
Second, sales of shelf-stable items, processed foods, and packaged foods are affected by lifestyle changes, consumer fads, economic cycles, and other factors. Companies with diversified product portfolios can not only weather storms but also deliver more consistent results. If you don't hold your cards well, then you can't take advantage of them when the moment is right.
The company leadership knows that its big challenge is making its private labels venture profitable. Officers will surely first look to consolidate warehouses, distribution centres, supply chains, and sales forces, and to eliminate acquired redundancies. Next, a private labels business poses a new challenge for ConAgra: the skill to cut deals with retailers per the latter's preferences.
If Rodkin & Co. don't do a please-the-Street sale and take their time to make a decision on divestments, their company will gain in the long term and its intended "year of stabilization and recovery," 2015, will be just that.
Things are Really Bad . . .
So are things really as bad as they are made out to be?
Amid a sea of middling and unimpressive stats, especially margin stats, the fat forward PEG ratio of 7.06 leaps out putting ConAgra in a league of its own at the 100th percentile - i.e. the very bottom of the pile! This metric implies that, adjusted for estimated earnings growth and normalized across sectors, CAG stock is 7 times overvalued. The average PEG ratio for the Food Products Industry is (only) 2.59. However, ConAgra is a consistent dividend payer with an annualized yield of 3.26%. In calculating the PEG ratio of income-oriented stocks - or, indeed, any stock that pays a dividend - strictly, the yield should be added to the growth rate to form the divisor but it appears that Fidelity does not do so.
The company also posted negative returns on equity, on assets, and even on investments. Currently it ranks well below the 50th percentile on all measures and metrics of return.
ConAgra's obese P/E ratio - surely widely known and much scrutinized - of 43.7 seems to indicate a much overvalued company, given its industry where multiples of 20 to 30 are the norm. However, it would be well to go past that traditional and obligatory first stop and look at a few other revealing ratios, comparing them with those of two similarly-sized peers with whom ConAgra competes in some or another product line: Campbell Soup Company (NYSE:CPB) and Hormel Foods Corp. (NYSE:HRL).
The P/S ratio, purer and more direct than the more widely-used and better-known P/E ratio, under certain circumstances is a more accurate guide to the health and future of a company. These circumstances include ConAgra's current situation of trying to integrate a large and awkward acquisition, having to make compromises with purchasers, and cut runaway costs. ConAgra's P/S ratio of 0.7 is exceptional and those of Campbell and Hormel at, respectively, 1.7 and 1.4 are not even close. The outstanding P/S ratio - the best in the entire peer group - implies that ConAgra stock is actually not overvalued, at least not on the most basic metric.
. . . Or Are They?
Unless you disbelieve the financials, ConAgra's P/B ratio is another indicator suggesting that the stock may not be overvalued, this time by way of B/S data. (P/B is a worthwhile ratio to examine for companies in capital-intensive industries that invest in and generate revenue from property, plant and equipment.) While Campbell and Hormel have P/B ratios of, respectively, 8.5 and 3.6, ConAgra's is only 2.5. Here too it is one of the top few in the peer group. Factor in (the various components of) ConAgra's goodwill (which are excluded from BV), and one may even start to think about a possible undervaluation.
Finally, though ConAgra's D/E ratio of 1.7 is an order of magnitude that of Hormel at 0.1, it is comparable to Campbell's at 1.4. One can explain this stat as the price - the so-called 'indigestion' - to be paid for the purchase of Ralcorp. That said, though ConAgra's D/E ratio is considerably more than that of competitor Hormel, compare with those of Kraft Foods Group at 1.9 or Kellogg Company at 1.5, of which Kraft is a competitor in multiple product lines.
Still, one of the major knocks on ConAgra is its debt load.
ConAgra has outlined a fairly aggressive debt reduction goal with a corresponding plan. On 21st July the company commenced a buyback of five senior notes from due 2017 to due 2043 of up to $500 million, which is a material though not substantial portion of those notes. At the same time, though, it issued notes worth $550 million maturing in 2016 but at a relatively low interest rate.
Finally, returning to the quarterly B/S, one sees that every single debt-related line item has stayed quite consistent QoQ for five successive quarters. Moreover, total debt, which is in the region of $9 billion, has not even increased; in fact, it has inched downward. The stories of debt load 'problems' may be a trifle exaggerated.
Who said things were bad? They don't look too bad by half.
The Skinny on CAG
TickerReport says that eight analysts rate CAG a 'hold' while three rate it a 'buy', and two, a 'sell'. The holds have a clear majority.
Insider activity can be a good pointer to the performance of a stock in the immediate future, posits Forbes in a piece titled "ConAgra Foods Named Top Dividend Stock With Insider Buying." It reports that a director "invested $99,847.44 into 3,300 shares of CAG, for a cost per share of $30.26." On the other hand, more recently TickerReport revealed that an EVP "unloaded 28,000 shares of the company's stock in a transaction that occurred on Monday, July 14th. The shares were sold at an average price of $30.63, for a total value of $857,640.00." Furthermore, on 16th June CEO Rodkin "sold 50,000 shares . . . at an average price of $32.44 for a total value of $1,622,000.00." In summary, directors and officers sold 200,000 shares in May and 250,000 in June, apparently selling more than they are buying.
What does not get reported is that directors and officers actually increased their CAG positions via what appear to be share awards, bonuses in the form of shares, or vestment of share grants. See a couple of SEC filings to this effect here and here.
Another pointer to the long-term safety and value of a stock is institutional ownership. Out of ConAgra's 422.5 million shares outstanding, 66% are held by institutional investors. That would include quite a few pension fund managers who are putting their faith in CAG for the long run. Increased and decreased positions, and new and cleared positions, are roughly even. Institutional owners' activity mirrors the cautious mixed signals from analysts.
ConAgra's YoY and QoQ negatively-trending performance does not justify a present stock price increase. That said, this company is not a Hormel, a Campbell Soup, or even a Kellogg. It operates in multiple segments, has stakes in staples like flour and potatoes, and has an enviable portfolio of consumer brands with excellent segment diversification, product mix, market penetration, brand recognition, and customer loyalty (some of which is probably reflected in its B/S goodwill line-item). These factors make a stock somewhat resistant to immediate and swift correction and Rodkin & Co. are probably utilizing this market fact to buy time to turn their ship around.
The signals, though mixed, have a trend. For now, the stock may have peaked and the action is around $31 which is probably its fair value estimate in FY 2015 Q1 (Autumn 2014). But we don't buy and sell stock based on fair value estimates today; we buy it at the market price today if we see it as fair value based on what its fair value estimate will be, say, six months or six years hence. The indicators are that within a year ConAgra will have increased its earnings as a consequence of which its stock price will rise. Further, CAG is a very strong dividend stock, impressive on both, dividend history and payout ratio. Anyone who buys the stock now will calculate their yield using the number 31 and not 41. CAG may well turn out to be a bargain at $30 to $31.
For value-shopping investors with shorter horizons it would be well to wait and watch: either management must do a course correction on costs and margins or the stock will do a price correction. However, for long-term 'buy and forget' investors, CAG is an easy 'Buy.'
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.