A Lot of Potential Upside for This Food Giant

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Recently, Warren Buffett teamed up with 3G, a Brazilian private equity firm, to acquire H. J. Heinz (NYSE: HNZ) at around $72.50 per share, with a total transaction value of $28 billion. After the deal's announcement, CEO Denise Morrison of Heinz’s competitor Campbell Soup (NYSE: CPB) said that the company decided to take a closer look at its own cost structure. In the past 10 years, Campbell Soup has maintained quite a stable operating margin, one that has only fluctuated in the range of 13.9% - 17.6%. Let’s look closer to determine whether or not Campbell Soup is a buy at its current price.

Business Snapshot

Campbell Soup, founded in 1869, is a manufacturer of high quality, branded convenience food products with five main reportable business segments: US Simple Meals, Global Baking and Snacking, International Simple Meals and Beverages, US Beverages and North America Foodservice. The majority of its revenue, $2.73 billion, or 35% of the total revenue, was generated from the US Simple Meal segment. The second biggest revenue contributor was the Global Baking and Snacking segment, with more than $2.19 billion in revenue. The International Simple Meals and Beverages ranked third, with $1.4 billion in sales in 2012.

A Closer Look at the Operating Margin

The business segment that delivered the highest operating margin, at 24.1%, was the US Simple Meals. The US Beverages segment ranked second with 17.3% operating margin. The International Simple Meals and Beverages segment seemed to be the least profitable segment, with only a 10.9% operating margin.

<table> <tbody> <tr> <td> <p><em>Operating margin</em></p> </td> <td> <p><strong>2012</strong></p> </td> </tr> <tr> <td> <p><strong>US Simple Meals</strong></p> </td> <td> <p>24.1%</p> </td> </tr> <tr> <td> <p><strong>Global Baking and Snacking </strong></p> </td> <td> <p>14.4%</p> </td> </tr> <tr> <td> <p><strong>International Simple Meals and Beverages</strong></p> </td> <td> <p>10.9%</p> </td> </tr> <tr> <td> <p><strong>US Beverages</strong></p> </td> <td> <p>17.3%</p> </td> </tr> <tr> <td> <p><strong>North America Foodservice</strong></p> </td> <td> <p>13.9%</p> </td> </tr> </tbody> </table>

Overall, Campbell Soup’s operating margin stayed at around 15.7% in 2012. Its operating margin was higher than Heinz’s operating margin at 12.5%. In 2012, Heinz experienced a nearly 30% drop compared to the operating margin in the past five years. The drop in its operating margin was mainly due to a lower gross margin and increasing admin costs.  The gross margin decline was due to the increase in industry-wide commodity cost, unfavorable sales mix, and a lower gross margin on its recent acquisitions. 

Quality Should Always Come First!

Campbell Soup’s 2012 operating margin was also lower than its historical two year operating margin. The lower operating margin was also due to a lower gross margin that was the result of higher cost inflation, higher level of promotional spending, and a lower sales mix. Interestingly, the higher selling prices in the past two years have helped Campbell Soup’s gross margin not to drop lower. CEO Morrison commented that the company kept looking for different ways to have better productivity. However, the quality of the products should not be compromised when the company aggressively cuts costs. Several years ago, Kellogg (NYSE: K), another Campbell Soup’s peer, had implemented the K-LEAN initiative to significantly reduce its operating costs. The K-LEAN initiative didn’t work too well, as it cut too many people in the US plant network. In the summer of 2011, the FDA revealed traces of listeria bacteria in its Augusta plant. As a result, several cereal products had to be recalled due to packaging problems, and there was a shortage of Kellogg's popular Eggo frozen waffles.

Campbell is the Cheapest

At the current trading price of $39.70 per share, Campbell Soup’s total market cap is $12.46 billion. The market is valuing the company at around 10.2 times EV/EBITDA. Kellogg has a more expensive valuation at 14 times EV multiple. When Warren Buffett acquired Heinz at around $72.50 per share, he valued Heinz at around 14 times EV/EBITDA. Among the three, Campbell Soup has the highest operating margin at 15.7% while Kellogg’s operating margin ranked second at around 13.9%.

Foolish Bottom Line

Among the three, Campbell seems to be the most profitable but relatively undervalued company. If Campbell has a similar valuation of 14x EV multiple, Campbell should be worth $22.4 billion on the market, or $70 per share. 


hoangquocanh has no position in any stocks mentioned. The Motley Fool recommends H.J. Heinz Company. 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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