Why ConAgra Foods Is Down 11% So Far This Year

You might think that a company operating in a stable business like food shouldn't have too much trouble posting decent results. After all, food is a basic need, and there will always be demand since people need to eat. But ConAgra Foods, (NYSE: CAG  ) has struggled mightily this year. That's because even within the food business, companies face constant pressures from competition and changing consumer preferences.

ConAgra recently lowered its full-year earnings forecast, and unveiled a poor fiscal fourth-quarter report in which sales and adjusted earnings per share dropped 2% and 8%, respectively. In turn, ConAgra's shares have performed poorly this year as well, down about 11% through the first half of 2014.

There is one particular product line that is causing a lot of trouble for ConAgra, and it's proving difficult for other companies in the same space, like Nestle (NASDAQOTH: NSRGY  ) .

Frozen foods are putting growth on ice
ConAgra management blamed most of its weakness on its consumer foods business, which is its largest segment. Within this unit, three core brands dominate: Healthy Choice, Chef Boyardee, and Orville Redenbacher's. Collectively, these three brands generate $1 billion in annual sales.

Volumes in ConAgra's consumer foods division dropped 7%, which was much more than the 3%-4% decline management expected. The main reason for this was simple: shifting consumer purchasing habits, particularly when it comes to frozen foods. This has Healthy Choice square in the cross-hairs.

Source: healthychoice.com

In the company's conference call with analysts, Chief Executive Officer Gary Rodkin plainly stated that frozen healthy meals are an extremely weak performing corner of the packaged food industry right now. This is a significant trend, since the frozen healthy meals business generates about $2.5 billion in annual sales industrywide.

Consumers simply aren't buying frozen single-serve meals to the extent they used to, and not surprisingly, that's having a ripple effect on Healthy Choice. This trend is having a similar effect on Nestle, which makes Lean Cuisine.

Sales of Lean Cuisine have fallen by 25% over the past five years. Industry research firm Mintel reports that consumers increasingly feel that frozen meals are too expensive and offer little nutritional value.

In response to the changing consumer landscape, ConAgra management is making several changes to the product line in an attempt to reenergize sales. First, ConAgra will eliminate several slow-moving Healthy Choice meals. In addition, the company will emphasize and expand its Café Steamers line, which is growing and carries satisfactory margins.

Don't expect dividend growth in the meantime
One of the redeeming factors behind investing in ConAgra is likely its dividend. And it's true that ConAgra offers you a solid 3.5% yield, which looks nice on the surface. But you should be concerned about dividend growth, in addition to the current yield. And, when it comes to ConAgra, there may not be much growth to its payout for a while, given its underlying fundamental struggles.

ConAgra hasn't raised its distribution in nearly two years, and it's likely it will hold its dividend steady for several more quarters. During the most recent conference call, management provided no reason to believe a dividend bump was in the near future. Management only went as far as to say that the company is committed to its current $1 per share annual payout.

Taking a conservative attitude toward the dividend makes sense, since ConAgra earned just $0.70 per share from continuing operations last year. That means its payout ratio is greater than 100% of last year's profits. As a result, ConAgra needs to get its fiscal house in order before it will be able to increase its payout.

A few final Foolish thoughts
ConAgra's sales and profits are going in the wrong direction, and much of it has to do with weakness in one of the company's major product categories. Frozen meals are struggling right now, as consumers increasingly opt for fresher alternatives. That's meant a lot of pain for ConAgra and Nestle. Nestle's financial performance has stayed strong, because it holds a giant portfolio of thousands of brands across both food and staples.

ConAgra, however, is a much smaller company, meaning it's more vulnerable to changing consumer habits. Sales of Health Choice are weak, and management will have to make meaningful changes to the product line if it's going to reverse the decline in its critically important consumer foods segment.

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