Will Market Pressures Continue to Plague ConAgra Foods?

ConAgra is reporting volume declines in its core business, and higher costs related to its major acquisition than it had anticipated. Here's what you need to know.

Jun 26, 2014 at 2:30PM

Packaged food company ConAgra Foods, (NYSE:CAG) seems to be on the wrong side of an evolving consumer landscape. There are signs that consumer preferences are shifting, away from packaged and frozen foods and toward fresher products like organics. Put simply, this is starting to have an effect on ConAgra's financial performance.

Food trends
Organic growth in the packaged foods industry was already hard to come by, as the industry is just about as saturated as it can get in the United States. Distributor Sysco Corporation (NYSE:SYY) is seeing the ramifications of this in its own financial performance.

In response to sluggish growth, ConAgra and Sysco have tried to generate growth through acquisition. While this has helped to boost the top line, ConAgra is struggling to produce growth on the bottom line. That's because the integration of their large takeovers isn't going as smoothly as initially anticipated. ConAgra was counting on sizable cost synergies as a critical component of its nearly $5 billion deal last year to acquire Ralcorp Holdings, a private-label company. That's not working out, and its profits are now bearing the brunt.

The situation facing ConAgra is fairly ugly. Here is what's unfolding at the company, and the ramifications for investors.

Not all is well
ConAgra's largest segment by sales is its consumer foods segment, which includes brands like Healthy Choice, Orville Redenbacher's, and Chef Boyardee. This division posted sales of $1.8 billion last quarter, but that represents a 7% decline year over year. It's worth noting that this wasn't the result of foreign exchange effects or pricing. The primary culprit was a 7% drop in volumes, which means people simply aren't buying these products as much as they used to.

In all, ConAgra posted a $115 million operating loss last quarter.

Top competitor Sysco is seeing challenges, as well. Its diluted earnings per share have declined 4% over the past three quarters combined. Sales growth is fairly sluggish, at just 3% in the most recent quarter.

ConAgra's three core brands mentioned above account for more than half of the total sales in the consumer foods business, and those are the ones struggling the most. Management noted that these three brands faced severe volume and profit challenges last quarter.

In response, ConAgra plans to announce promotional changes. The company expects performance of its key brands to improve in the upcoming fiscal year, but of course there's no guarantee of this. That's especially true if the company turns to discounting as a means of reenergizing sales.

Private brands aren't coming to the rescue
ConAgra has likely known for some time that its consumer foods segment was struggling. In response, the company sought to build its private-label offerings. To do this, ConAgra acquired Ralcorp Holdings, which it hoped would boost sales in its private-label brands. It's accomplished that goal in a way. ConAgra's private brands generated $1 billion in sales last quarter.

However, ConAgra is incurring significant costs in integrating its acquisition. Earlier this month, the company warned investors the integration wasn't going as smoothly as it had hoped. To that end, ConAgra's private brands segment posted a $573 million loss last quarter, due to significant impairment charges. Management attributes this to "higher-than-planned operating costs resulting from business transition."

The same pressures are hitting Sysco. Its earnings per share fell 8% in the most recent quarter, due primarily to merger and integration expenses related to its $3.5 billion takeover of close competitor US Foods.

ConAgra's situation isn't likely to improve in the near-future, either. Operating profits in the private brands segment are expected to drop again in the first half of fiscal 2015. That's because ConAgra is resorting to pricing concessions with customers.

Is the dividend enough?
ConAgra offers you a solid 3.5% dividend yield, which is attractive for those looking for income. That level is higher than the yield available from most other stocks, and certainly compares favorably to bonds as interest rates are still near historic lows.

But even a solid dividend yield will be little consolation if the underlying business deteriorates. ConAgra expects continued difficulties for the first half of the fiscal year, then recovery in the latter half. It's up to management to make sure the elevated acquisition costs don't persist, since ConAgra has enough core structural problems in its key segments as it is.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Sysco. 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.

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