Increased Costs Limit ConAgra's Earnings

| About: ConAgra Brands, (CAG)

ConAgra foods Inc. (NYSE:CAG) reported results for the second quarter of fiscal 2011 with earnings per share (EPS) of 45 cents, exactly in line with the Zacks Consensus Estimate.

However, EPS (excluding a one-time expense) of 45 cents was down from 52 cents in the year-ago quarter, and net income was $200.9 million, down 16.2% from $239.7 million in the second quarter of fiscal 2010. Slower market recovery as well as increased costs negatively affected EPS.

Net revenues marginally moved up to $3,161.1 million from $3,100.1 million in the corresponding quarter of fiscal 2010, representing an increase of 2.0% year over year. Reported revenue was also above the Zacks Consensus Estimate of $3,157 million. The increase in total revenues was due to a 3.4% increase in revenues from the Commercial Foods segment and a 1.3% rise in the Consumer Food segment.

Revenues from the Commercial Foods segment rose based on improved prices for flour milling operations and enhanced volumes for Lamb Weston specialty potato products. The increase in revenues from the Consumer Foods segment was based on improved organic volume growth.

As a percentage of revenues, cost of goods sold (COGS) climbed by 320 bps while SG&A (selling, general and administrative) expenses dropped by 110 bps. Corporate expenses were $79.0 million, down from $94.0 million during the same period of the previous year based on lower incentive compensation expenses during the quarter. Increased COGS primarily resulted in the EPS decline, but the company is expected to save $275 million in fiscal 2011 through its various cost reduction initiatives.

At the end of the quarter, operating cash flows dropped to $319.1 million from $657.2 million at the end of second quarter of fiscal 2010 based on working capital adjustment. During the quarter, ConAgra spent $82.0 million as capital expenditures for property, plant and equipment compared with $123.0 million in the year-ago period and paid a total dividend of $88 million compared with $84 million in the year-ago quarter. During the quarter, ConAgra authorized $554.0 million of share repurchase.

ConAgra expects 2011 EPS growth in the range of 5%-7% over the fiscal 2010 EPS of $1.74.

We reiterate our Neutral recommendation on the stock based on a gradual market improvement. ConAgra's various strategic moves also significantly enhance its portfolio. In the first quarter, ConAgra acquired American Pie for approximately $130 million and divested Gilroy Foods & Flavors dehydrated vegetable operations to Olam International for $250 million. The company's plan to save $275 million in fiscal 2011 through cost-reduction initiatives also inspires our optimism.

However, the highly-competitive food industry and extremely volatile commodity prices are matters of prime concern. ConAgra’s direct competitors are HJ Heinz Co. (HNZ) and Kraft Foods Inc. (KFT).

Thus, the stock currently retains its short term "Sell" rating, equivalent to a Zacks #4 Rank.