Should Investors Bite on This Stock?

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Is ConAgra Foods (NYSE: CAG) really a safe play if the market tanks? We’ll take a look at what makes ConAgra appealing, as well as what makes it dangerous.  

The Ralcorp deal

If you have been following ConAgra Foods, then there’s little doubt that you have read about the Ralcorp deal. Last November, ConAgra announced that it would acquire Ralcorp for $90 in cash per share.  If you’re long ConAgra Foods, then you’re probably excited about the deal.

While there has been much information about the Ralcorp acquisition and its potential, there hasn’t been much information about Ralcorp itself.

Ralcorp is the country's leading provider or private-brand foods. It distributes these foods to quick service and casual restaurants, supermarket chains, drugstores, bakeries, and mass merchandisers. Products include ready-to-eat cereals, nutritional and cereal bars, snack mixes, chocolate candy, salad dressings, condiments, dry pasta, corn snack products, syrup, pancakes, French toast, waffles, and pre-baked goods. This list is highly diversified, which is a big plus. 

Another plus is that Ralcorp has 13 facilities throughout the United States and Canada that help reduce time and labor costs. Perhaps the most important point of all is that Ralcorp saw a 12% compound annual growth rate over the past 10 years. Furthermore, private brands save consumers an average of 30%, which makes this acquisition a wise one based on the current macroeconomic environment, where consumers are looking to save money at every corner.

Citigroup analyst David Driscoll stated that this acquisition could add $0.39 to earnings for the year, as opposed to ConAgra’s estimate of $0.25. Citigroup has added ConAgra Foods to its Top Picks list and set a $41 price target. At the time of this writing, ConAgra trades at $33.12. 

ConAgra vs. peers

The knock on ConAgraFoods has been that while its marketing costs increase, sales volumes still decline. However, ConAgra Foods expects sales volume to be much higher this quarter, and we don’t know the real future potential of the company after the Ralcorp acquisition. Considering ConAgra Foods products are already found in 97% of American homes, the company would likely be able to withstand any challenging economic environments. Adding Ralcorp simply increases the company’s reach and potential.

On the other hand, debt is a concern. ConAgra Foods is now a highly leveraged company with a debt-to-equity ratio of 2.07 versus an industry average of 0.80. That said, Kraft Foods (NASDAQ: KRFT) and Hillshire Brands sport debt-to-equity ratios of 2.66 and 2.25, respectively. Kraft Foods has been a popular trade, performing well since the spinoff of Mondelez and its snack segment, but the lack of international exposure could limit the company's future potential. 

Treehouse Foods (NYSE: THS)only has exposure to the United States and Canada, but if you're looking for a company with quality debt management, then it might be the best option as it sports a debt-to-equity ratio of 0.72 -- below the industry average. The “negative” for Treehouse Foods is that it doesn’t offer any yield.

ConAgra Foods currently yields 3%, Kraft Foods yields 3.70%, and Hillshire Brands yields 1.50%. Though some investors will look at a lack of dividend payments as a negative for Treehouse Foods, it should be looked at as a positive, because it keeps the company fiscally responsible, which means Treehouse Foods is likely to hold up better than peers if the market suffers a steep correction.

Pricing is another concern for ConAgra Foods. As competitors lower their prices and offer promotions, ConAgra Foods stands firm on its pricing. This might work well for right now, but if the consumer weakens, then ConAgra Foods could find itself behind the curve. That said, the Ralcorp acquisition will provide ConAgra with impressive product diversification, which means strong demand is likely to come from somewhere.  

Conclusion

ConAgra Foods is a well-managed company that has accomplished product penetration in almost every home in the United States. Risks exist due to a weak consumer, but ConAgra Foods is constantly looking for ways to cut costs in order to maintain profitability. The Ralcorp acquisition gives ConAgra Foods tremendous potential, but debt is a concern.

Right now, upside potential outweighs downside risk for ConAgra Foods. But if you’re looking for safety, then Treehouse Foods is likely to be a better option. 


Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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