Campbell Soup (CPB 0.29%) has seen better times. The processed food and snacks company, with its iconic "Campbell's" brand of soups, has suffered falling operating and net income over the last two fiscal years. Though the company delivered revenue growth over that same period, net income tumbled from $887 million to just $211 million, a steep 76% plunge.
Campbell's problems seem to be two-pronged: First, the company's gross margin has been weakening, starting out at 41.8% in fiscal 2017 and declining steadily to 35.9% in 2018 and then 33.2% the following year. This seems to demonstrate a lack of pricing power. Second, the company has a boatload of debt that cost the company $356 million in interest last year. Gross debt stood at $8.3 billion against just $61 million of cash as of Oct. 2019.
The company has a stable of strong, iconic brands and has counted itself as one of the premier food stocks for investors over the decades. In the last six months, Campbell has announced a series of divestitures to raise cash and realign its business for growth. Can investors rest assured that the company is now on the right track?
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A string of divestitures
With such a heavy debt load, management started to sell off various businesses during calendar year 2019. In February, Campbell parted with its U.S. refrigerated soup business and in April, it sold Garden Fresh Gourmet. Total net proceeds amounted to $55 million. In June, the company let go of Bolthouse Farms for approximately $500 million and in July, its Kelsen business fetched $300 million.
In the biggest of its divestitures from last year, Campbell sold its Arnott's biscuit business for around $2.2 billion. A month later, the European chips business sold for around $80 million. This string of divestitures is expected to generate aggregate net proceeds of $3 billion for the company and will help to alleviate its debt load and generate cash for working capital purposes.
New operating model
Now, the company is focusing on building strong brands with a strategy that consists of two core divisions (snacks and meals & beverages) and 13 categories that represent nearly 80% of total sales. Management has also implemented a four-pillar strategy along with a new operating model that promises to focus on both growth and optimization of the company's cost structure.
The first pillar is to create a profitable growth model by focusing on the Pepperidge Farm and Snyder's-Lance brands within the snacks division. Investments will be made to model Snyder's-Lance after Pepperidge Farm as the latter has shown promising 3% compound annual growth over the last three years. New products will also be introduced for the Goldfish, Cape Cod, and Kettle brands, and these will be funded by cost savings from recent integration efforts.
Management is also focusing its attention on turning soup around, as this is a $4 billion category that has strong brand recognition. The company has developed a three-year road map that will more clearly define the many brands within the soup category, cut time for research and development, and transform retail and channel presence.
The second pillar is to fuel investments with targeted cost savings. The idea is to drive total enterprise savings of $850 million by the end of the fiscal year 2022. So far, $560 million of this goal has already been achieved in the previous fiscal year, with another $290 million earmarked for the next three years.
The third pillar is to build a winning team and culture by adopting a different metric-driven incentive structure. This will now be based on three metrics: net sales, adjusted earnings per share (EPS), and cash flow. By linking compensation to these three key performance indicators, management hopes to drive the right behavior through alignment of objectives.
Finally, the last pillar is aptly titled "deliver on the promise of our purpose." This will incorporate sustainability practices into the supply chain and enhance employees' connections to the communities where people work and live.
A three-year transformation plan
Management has worked out a three-year "transformation" plan based on the above four pillars. For fiscal 2020, the goal is to stabilize the business after the aforementioned divestitures. For fiscal 2021, acceleration is the goal, with growth being a key objective for the company as it starts to deliver on these many initiatives. By fiscal 2022, Campbell plans to sustain this momentum and deliver steady and sustainable growth.
The company's long-term target is to achieve annual growth of 1% to 2% for organic sales, 4% to 6% for adjusted earnings before interest and taxes, and 7% to 9% for adjusted earnings per share.
Tempting prospects, but execution is key
Personally, I find the above objectives and transformation plans lofty. It's a good start for management to identify what went wrong and to stem the decline, but for growth to restart, execution and focus are essential.
Campbell's problems lie with both profitability and its high levels of debt. While alleviating some of the debt through its divestments may buy the company breathing time, ultimately, it has to continue to reduce more of this crippling burden through higher levels of free cash flow generation if it is to stand a chance in growing its net income.
As for gross margins, the stated initiatives will take time to work their way through Campbell's portfolio, but I am optimistic on this front, as the company has a strong, recognizable stable of brands that it can leverage.
All in, I believe the company has a solid, coherent plan for turning the business around, but growth is still probably at least one or two years away.
