Campbell Swamped?
Or can it boil off its problems?

by Jeff Fischer (TMFJeff@aol.com)

ALEXANDRIA, VA (Feb. 18, 1999) -- On Tuesday, Campbell Soup (NYSE: CPB) reported earnings per share of $0.49, down from $0.63 last year. Net sales in Campbell's second quarter of fiscal 1999 were $1.83 billion, down 9% on a reported basis (down 4% before the impact of currency and divestitures). Net earnings were $219 million compared to $300 million last year.

Part of the downdraft in results is due to Campbell's recent cost-saving initiatives in its supply chain, which resulted in lower soup shipments. Though paying a price now (in the form of lower earnings), over the long term the company should save $100 million annualized from the new inventory process, which should result in even higher margins for the company.

Following a steep price decline, shares of Campbell Soup are trading at 22 times 1999 earning estimates, a valuation level last seen in 1996 (when it actually traded below that P/E). Part of the reason for the low valuation is the lack of visibility (or reliable predictability) in forward earnings. That's a temporary issue, however. Once supply chain issues are configured, the company's results should again be more predictable. The question is: how long will it take for initiatives to be fully instituted and working smoothly?

Uncertainty creates a lower valuation.

Another reason behind the lower share price is the disappointment regarding recent results. The company increased advertising and it still saw condensed soup sales decline, while sales of generic brands grew. That's worrisome. However, if Campbell can continue to innovate with new soups and price incentives (incentives that are more possible if the company lowers its own costs), then this problem could be more or less temporary, too. After all, Campbell still owns 80% of the U.S. condensed soup market.

For the first half of this fiscal year, the company was happy to see wet soup sales in the U.S. grow over 3%. That growth was driven by sales of ready-to-eat Chunky and Simply Home soups. The ready-to-eat soups have experienced 10% sales growth year-to-date, which is ahead of expectations.

So, condensed soup is still the drag. Because of weak sales in this area, soups and sauces saw total revenue decline 8% to $1.28 billion this quarter. Condensed soup accounts for 65% of Campbell's soup volume, so no matter how successful new products are (and they have been very successful), the company is at the whim of condensed soup. Next year, management is hoping to increase condensed soup volume 1%. That's doesn't sound like a number to jump up and down about, but that's the soup business for ya.

On the more optimistic side, the company reiterated its long-term goal of achieving sales growth of 8% to 10% annually, with volume and mix accounting for 5% to 6% of results. That's a nice goal if management can achieve it. With 8% to 10% sales growth, the company should be able to put up earnings per share growth of 12% to 14%. But let's cross that bridge when we get there -- if we do anytime soon.

For the six months ended January 31, 1999, total sales were $3.63 billion compared to $3.82 billion last year. Sales were actually up 2% before the impact of currencies and divestitures, and were down 5% as reported. Earnings per share were $1.07 compared to $1.18 in the first six months of 1998, down 9%.

For the second quarter, gross margin rose 70 basis points (that's nice!) to 53.3%, due to cost savings; although selling, general and administrative costs increased to 33% of sales from 28%, and marketing expenses (as expected) rose 6%. The recent improvements in margins are not in danger, at least, and eventually margins should be able to improve more, once again, after the new inventory model is complete.

Estimates call for Campbell to grow about 12% annually in the long term, with $1.90 per share in earnings this year (down 3%) and $2.11 next year (up 11%). At $42, the stock trades at 22 times this year's estimate and 19.9 times next year's guess. Campbell shares yield 2.20%. All in all, this is not a bad valuation for a leading company with, arguably, limited downside risk. An investor needs to be willing to wait at least a few years to see results, however, and she must have faith in management's long-term initiatives to grow soup volume.

We'd probably send money to Campbell now if not for the $5 optional cash purchase fee involved. Because of this fee, even if we send all $100 to Campbell this month, we'd be tagged with a 5% purchase fee. For a company that might grow 11% in the next 18 months, paying a whole 5% fee just to buy the stock is too heady. As a rule, the Fool recommends paying no more than 2.5% in commissions for any transaction. And even 2% is high in a world of discount brokers. However, if we save up $200, we might invest in Campbell -- might -- because then the fee would be 2.5% of the investment and the price and yield is decent.

This Month. This month we'll again send $100 to Mellon Bank (NYSE: MEL). That'll be sent Monday, February 22. (By the way, we received a dividend check from Mellon this week. That won't happen again: we now own five shares of Mellon Bank, so our dividends can be reinvested in stock automatically. Five was the minimum.)

We'll also send $40 to Johnson & Johnson (NYSE: JNJ) next Monday. You might recall that we sent $40 to Intel (Nasdaq: INTC) last fall but it was never received (unfortunately, because the stock was around $80 then). We'll send that money again, but this time to J&J in order to continue balancing our positions.

Speaking of J&J, the stock rose earlier this week on news that the Food and Drug Administration (FDA) has licensed the company's new confirmatory test to detect hepatitis C virus antibodies in human blood. The product was developed with Chiron (Nasdaq: CHIR).

J&J trades at 28.9 times a $2.98 per share estimate for this year, and 25.6 times the year 2000 estimate of $3.36 per share. The company is expected to grow earnings about 13% annually. For more on J&J's upcoming drugs, see our year-end column.

So, to summarize, we'll send $100 to Mellon Bank and $40 to J&J next Monday. Remember, we didn't add this month's $100 to the Drip Port yet, but we will as the money is invested. Tomorrow is Touchstone Friday and next week we'll continue to burn through oil. Questions, comments, flames? Visit the message board to discuss anything drippy.

Fool on!

[To discuss these columns, please visit the Drip Companies message board on the Web.]

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