Is This Stock A Healthy Choice?

By Chad Henage - July 10, 2012 | Tickers: CAG, HNZ, KRFT | 0 Comments

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Many people know the brands that ConAgra (NYSE: CAG) owns like Healthy Choice, Chef Boyardee, and PAM. However, many people don't know much about the company behind these brands. ConAgra has been busy acquiring brands that are complimentary to their existing portfolio. While these brands should add to the company's potential, ConAgra is facing difficult competition in nearly every category it competes in. Looking at the company's most recent earnings report can give investors some insight into what's going on at the company. The company's dividend yield of just over 3.7% might look tempting, but if you look deeper at the numbers, they tell you the healthy choice is to stay away.

Competition:

ConAgra competes in the grocery store aisles with many large and well established companies. One of the more heated rivalries is that of ConAgra's Hunt's brand versus the more dominant Heinz (NYSE: HNZ). The company also competes with the likes of Kraft (NASDAQ: KRFT) in that Kraft has been coming after ConAgra's Reddi-Whip brand asking, “would you like oil or cream?”. These are hardly the only direct comparisons, but you get the idea. ConAgra is competing head-to-head with multi-billion dollar conglomerates on a day to day basis. Look at the difference between ConAgra's performance versus just these two competitors on just a few metrics.

(FCF payout ratio based on last full year financials) 

You can see that on most of these metrics ConAgra competes fairly successfully. The one big issue appears to be gross margin. ConAgra could be forgiven for this lower gross margin, if the company's sales were tremendously less than the other two companies. However, Heinz has nearly the same sales that ConAgra does, yet their gross margin is nearly 11% higher. This might be due to the types of food products that the company offers, but Kraft is pretty diversified and yet manages a gross margin that is much higher as well.

Earnings Report:

ConAgra operates basically two primary divisions, consumer foods and commercial foods. Overall diluted EPS grew 9% to $0.51 which was a penny ahead of earnings estimates. The consumer foods segment makes up 63% of total sales and has struggled for multiple quarters until this earnings report. While the company only showed sales growth at 11 out of 26 brands, this was enough to post a 6% increase in sales. The company mentioned this 6% increase in sales as a bright point in the earnings report, but what you had to read a little further to find was the 26% decrease in profits. The most troubling was how consumer foods posted this 6% increase in sales. The company's 6% increase in prices, and 6% increase from acquisitions should have resulted in a 12% increase in sales. The problem was, 5% less volume sold, and a 1% decrease due to foreign exchange, cut this growth in half. When a significant drop in volume causes a 12% growth rate to be cut in half, investors need to be worried. Price increases and acquisitions won't happen every quarter, and imagine what results would have looked like without these two positive factors. Commercial foods, which makes up 37% of total sales performed much better. The story here was pretty straightforward. A 7% increase in sales equated to a 7% increase in profits. This earnings report wasn't what I would call impressive, and the company's guidance says to expect more of the same next year if not a little less.

Outlook for 2013:

ConAgra management expects a 6-8% increase in EPS and operating cash flow of “at least $1.2 billion”. Just to make sure everyone catches this, operating cash flow is not the same as free cash flow. In fact, if the company delivers $1.2 billion in operating cash flow, this will be second lowest number in the last four years. While this would represent growth of about 14% in operating cash flow versus 2012, one has to wonder if the company reported without acquisitions what this number would be like.

Balance Sheet & Financials:

ConAgra's balance sheet has taken a hit in the last year primarily due to acquisitions. In fact, the company has used nearly $900 million in cash in just the last year. Where the company's dividend is concerned, it appears to be covered at this point. As of the last quarter, ConAgra generated just over $1 billion in operating cash flow, spent $400 million in capital expenditures, and $389 million on dividends. With a free cash flow payout ratio of 59.51%, investors shouldn't worry about the dividend yet. The troubling part about the company's payout ratio is, two years ago it was 35%, last year it moved up to 43%, and today it's getting close to 60%. However, if the company delivers on its $1.2 billion operating cash flow promise, with an expected $400 million in capital expenditures, and about $400 million in dividends, the payout ratio should be about 50%.

Conclusion:

Overall, ConAgra is what I refer to as a middle of the road pick. The company does enough well to stay on my watchlist. Investors best opportunity would be to wait for one of the inevitable drops in the market, to pick up shares at a lower price. Even at about 13 times forward earnings, the stock doesn't look like much of a bargain, with just a 6.5% expected growth rate. While the dividend of 3.71% is nice, Heinz has almost the same dividend, with a better growth rate, and lower payout ratio. At this point, if someone told me I had to buy one or the other I would go with Heinz.

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