JUPITER, FL (Nov. 16, 1999) -- Campbell Soup (NYSE: CPB) reported first quarter 2000 results this morning, so we will cover them before they get cold. We brewed up our current food and beverage study in order to find a replacement for Campbell Soup, mainly due to the fees instituted in its direct investment plan, and only very slightly due to Campbell's lack of near-term success with its business initiatives. It is too soon to measure the true success of management's actions, truly, so they don't play much of a role in our decision. Let's see how the company is progressing.

Campbell reported results that seeped below last year's performance. Sales at the soup giant fell 2% from one year ago, to $1.77 billion, while net income declined 11% to $235 million. The company earned $0.54 cents per share, down from $0.58 cents last year. Despite the decline, results topped estimates by a wide margin, as the consensus earnings estimate was just $0.49 per share.

The most important metric to watch, wet soup volume, declined 4% in the U.S. and 2% internationally. The decline in the U.S. was blamed on a lack of aggressive advertising, which Campbell saves for its seasonally strong second and third fiscal quarters. (I don't watch much television, but I have seen a great deal of Campbell advertising since October began.) The decline in international volume was blamed on weakness in Canada and in the U.K. (Click here to harass The Fool U.K.) All other international markets saw strength. Overall, worldwide wet soup volume slipped 6% from last year, not painting a pretty picture.

There is reason to be optimistic, however, and the situation probably contributed to the stock's 5% climb this morning. First, this was the last quarter of unfavorable year-over-year comparisons for Campbell Soup. As you probably recall, the company began to remodel its inventory practice several quarters ago, and in the process it warned that quarterly results would slacken. What was management doing? Smart things. The company has essentially canned (sorry for the bad pun) its end-of-quarter soup promotions.

In the past, Campbell offered retailers soup at a discount in order to end each quarter on a strong note, because of course retailers stocked up at the discount prices. The problem, as Brian alluded to last Friday, is that soup doesn't go bad for years, and therefore retailers would have so much in stock that they didn't need to buy canned soup again for a few months. Finally, when they did buy again, they would buy it when the discount was offered at the end of another quarter. Campbell management quit the quarterly discount like a bad habit in order to streamline how inventory flows out of the factory and in order to increase its income per sale.

Logical, simple, smart.

However, it took several quarters for retailers to blow through existing inventory before they would buy quantities of soup again. Few retailers rushed to buy the now "full-priced" soup before they sold the discount soup they had stocked. So, quarter after quarter, sales were lower than one can realistically hope for in the future. This inventory situation is finally straightened out, according to management, and the poor year-over-year comparisons of the past now turn into favorable year-over-year comparisons for the next year. Sales slumped in the past year. That only makes it easier for Campbell to grow next year. We saw this sort of seesaw action with Johnson & Johnson (NYSE: JNJ), too. It had a slow 1998, which helped it achieve stronger-than-usual growth in 1999.

Despite a boost in sales that one can hope for in the coming year, the main concern at Campbell remains soup volume growth over the long term. It is estimated that in the past year, industrywide wet soup volume rose only 1% in the U.S. Tacked onto that, prices rose about 1%, bringing total growth to 2%. Campbell's goal is 4% to 6% annual growth in this metric. The company continues to earn a majority of its profits from U.S. wet soup sales, and despite consistent growth in Pepperidge Farm, Godiva, and Away From Home divisions, wet soup is the company's lifeblood. (Yummy image!)

In the efficiency department, Campbell's cost-cutting continues to offer rewards. Campbell Soup increased cash flow from operations more than 40% over last year, to $261 million, allowing it to easily buy back $155 million in company stock. Gross margin topped 54.2%, up from 53.9% last year; operating margin totaled 23.2%, down from 24.7% last year. The decline was due to higher selling, general, and administrative expenses. We'll see where this figure goes next quarter.

The company is expected by analysts to grow earnings per share 10.2% annually the next three to five years. Year 2000 estimates are likely to rise, but at a recent price of $46.50, Campbell trades at about 24 times 2000 estimates and 22 times 2001 estimates. It yields 2%.

The business quality of Campbell Soup is still well above average; the business risk is less than average; the stock valuation is also below average relative to the S&P 500, which trades at a P/E of 28. As a long-term holding, I don't believe that Campbell can hurt Drip Port -- not by any means. It will almost certainly make us money. But will it top the market? And can another company in this industry beat Campbell? This is what we're trying to determine. We'll push onward in our food and beverage study tomorrow.

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