Shares of ConAgra Brands (NYSE: CAG) plunged 17% on Dec. 20, after the packaged foods giant followed up its second-quarter earnings with light guidance. A broader sell-off across the markets, sparked by the Fed's rate hike and soft outlook for the U.S. economy, exacerbated the pain.
ConAgra's revenue rose 9.7% annually to $2.38 billion, beating expectations by $10 million. However, most of that growth was attributed to its acquisition of Pinnacle Foods in October. On an organic basis -- which excludes the acquisition, the sale of a Missouri production facility, and other one-time gains -- its revenue fell 1.6%. ConAgra attributed 2.2 percentage points of that decline to the impact of hurricanes in the prior-year quarter.
ConAgra's adjusted diluted EPS from continuing operations rose 22% annually to $0.67, which beat expectations by $0.10. However, its reported earnings fell 40% to $0.32 per share due to acquisition costs and other expenses.
For the full year, ConAgra expects its adjusted EPS from continuing operations to decline 1.4%-3.8%, compared to the consensus forecast for 0.5% growth. It mainly attributed the shortfall to some softness in Pinnacle's year-end sales. On the top line, ConAgra expects its reported revenue to rise 22%-23%, which matches the consensus estimate. On an organic basis, it forecasts its sales to rise 1%-2%.
ConAgra's headline numbers were mixed, but the post-earnings sell-off seemed like a knee-jerk reaction that significantly lowered its valuation and boosted its yield. Should contrarian investors buy this dip, or is this stock headed lower before it bounces?
Understanding ConAgra's business
ConAgra's core portfolio includes well-known packaged food brands like Slim Jim, Marie Callender's, Orville Redenbacher's, Hunt's, Duncan Hines, and Vlasic. However, the company struggled in recent years as consumers' interest in its core brands waned.
To counter that shift and diversify its portfolio, ConAgra acquired popcorn maker Angie's Artisan Treats in 2017, then bought Pinnacle Foods -- the maker of frozen and shelf-stable brands like Vlasic, Duncan Hines, and Hungry Man -- last year.
Those acquisitions helped ConAgra break its streak of revenue declines with five straight quarters of top-line growth. However, its organic sales growth -- which gives investors a clearer picture of the health of its core products -- remains weak.
Net sales growth (YOY)
Organic sales growth (YOY)
Data source: ConAgra quarterly reports. YOY = year over year.
During the second quarter, ConAgra's grocery and snacks revenue stayed flat year over year on a reported basis, but fell 1.9% on an organic basis. Sales of its refrigerated and frozen products rose 1.7% year over year as reported, but its organic sales inched up just 0.5%.
That soft growth is disappointing -- but it isn't surprising, since many of ConAgra's peers are also buoying their sales growth with acquisitions while struggling to grow their organic sales. For example, General Mills (NYSE: GIS) reported 5% sales growth in its latest quarter , but most of that growth came from its acquisition of pet food maker Blue Buffalo. On an organic basis, General Mills' revenue still fell 1%.
Margins and earnings growth
ConAgra's adjusted operating margin rose 181 basis points annually to 17.5% during the quarter, thanks to a higher-than-expected gross margin at its legacy ConAgra brands (driven by price hikes and productivity improvements to offset inflation) and lower operating expenses.
For the full year, ConAgra expects to report an adjusted operating margin of 14.9%-15.2%, with Pinnacle's slightly lower margins (14.6%-14.9%) offsetting the higher margins of its legacy ConAgra brands (15%-15.3%).
ConAgra also expects Pinnacle's full-year sales for calendar 2018 to come in 5% below its pre-deal target. The combination of Pinnacle's lower margins and softer sales contributed to the company's weak earnings forecast for the full year. However, the company still claims that the Pinnacle acquisition remains on track to deliver over $215 million in cost-cutting synergies.
The valuations and verdict
At $23, ConAgra stock trades at 11 times this year's earnings and pays a decent forward yield of 3.5%. However, General Mills isn't much pricier at 13 times this year's earnings, pays a higher yield of 5%, and recently posted full-year revenue and earnings guidance that exceeded analyst expectations.
I think ConAgra's business should stabilize after it fixes the issues at Pinnacle, but I don't think the stock is a compelling buy in a wobbly market. If investors are looking for a bear market-friendly packaged foods stock, General Mills is probably a much better pick than ConAgra at these prices.
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