What Makes ConAgra a Good Investment?
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While ConAgra Foods (NYSE: CAG) failed in its recent attempt to buy Ralcorp Holdings (NYSE: RAH), we continue to believe that each disciplined deal lends more credibility to CEO Gary Rodkin’s plans to grow ConAgra’s significant cash earnings power through patient use of the balance sheet.
Small deals like this, Del Monte Canada, Odom’s, and National Pretzel together have deployed roughly $900 million in the past twelve months, with much better returns per unit of risk than would be available in a single deal of that size. ConAgra will look to leverage its balance sheet to create shareholder value via some combination of buybacks, acquisitions, and dividends. As such, even in the absence of a compelling near-term catalyst, we still see a room for upside.
PHASE-I was just a trailer
Let's first talk about what management referred to as “Phase-I” of its long-term strategy. Over the last 5 years, Rodkin and his management team have transformed ConAgra from a holding company to a fully integrated operating company. During this phase, the stock has traded at a double-digit discount to its peers, which we believe was justified given that in addition to relatively less sales growth, the company’s ROIC and EBIT margins were below its peer group average.
PHASE-II can be even better
Now, going into the Phase-II, which the management refers to as “Recipe for Growth,” the company is well positioned to attain a faster growth profile. Still, the long-term guidance range of 6-8% is slightly below its peer group, which averages around 8%. The management guided for EPS of $1.84 in 2012. EPS growth is driven by the impact of acquisitions, growth in its Lamb Weston potato operations and margin management. The company guided for a mid-single rate of inflation. Going forward, we are optimistic about the stock given highly overlapping acquisitions in Bertolli and P.F. Chang’s, the potential for a value-enhancing corporate split-up and strong dividend.
Highly Overlapping acquisition of P.F. Chang’s and Bertolli Frozen Meals
Last month, ConAgra announced an agreement to acquire the chief North American frozen foods assets of Unilever for $265 million. Bertolli and P.F. Chang’s will support ConAgra’s heavily dinner-focused product offering with items that will strengthen ConAgra in alternate channels. Frozen foods will now comprise over 40% of ConAgra’s retail revenues. This strong overlap indicates the opportunity for cost synergies; offsetting concerns posed by increasing protein costs (represent 22% of COGS). We believe it is low-risk deal and improves both positioning and mix. The deal is unlikely to have a meaningful impact in the near term but we believe there is a possibility of accretion in FY14 as service agreements with Unilever roll off.
Potential for a value-enhancing corporate split-up
Although the management has not indicated any potential split-up, we believe the company can follow the footsteps of Sara Lee and Kraft Foods. Sara Lee has already split up into two and Kraft Foods (NASDAQ: KRFT) is all set to spin-off of its grocery business in North America from its snacks business in October. ConAgra’s consumer foods division, which represents 63% of revenues and 66% of operating profits, may split off as a separate unit in tune with the industry's current pattern. Any such announcement may prove to be catalyst for a significant stock appreciation.
Over the last decade ConAgra’s stock price has failed to consistently deliver strong returns and investors have only received their annual dividend yield, which currently runs at 4%. However, we expect the company’s exposure to the fast growing Private Label and International markets to increase meaningfully over the next few years. If the company is successful in executing its strategy, we see a valuation upside; narrowing the gap relative to its peers. Furthermore, as a result of the divestitures of several commodity/trading type businesses, we believe the company’s portfolio is more stable than before and should result in consistent earnings growth and cash flow. Moreover, we anticipate an upside in FY13 earnings as we believe consensus estimates are not fully incorporating the impact of easing commodity inflation (commodity inflation expected to be less than ~5% compared to last year’s 10%) and potential for share buybacks. Thus, we recommend it a buy.
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