Like many food companies able to switch away from supplying restaurants to addressing skyrocketing consumer demand for staples during the coronavirus pandemic, Conagra Brands (NYSE:CAG) posted strong gains in revenue and earnings per share once it bounced back from the virus' initial economic punch.
In fact, the packaged-food company gave its dividend a large hike simultaneously with reporting a profitable first quarter in fiscal year 2021. The company's challenge now is to keep those gains and maintain its higher dividend as the COVID-19 boost to staple sales subsides.
Laying the groundwork
Conagra has spent the past half-decade pursuing The Conagra Way. That's not some blend of Eastern mysticism and packaged snacks, as its name might suggest, but a strategic blueprint for modernizing the company and making it more competitive. CEO Sean Connolly described the plan to the Chicago Tribune, as reported by Strategy&, the strategy consulting unit of PricewaterhouseCoopers.
Saying that The Conagra Way's operational changes are "not for the faint of heart," Connolly described how the company streamlined its management to eliminate overgrown bureaucracy, while also slashing expenses not as "an end in and of itself, but instead as the means to free up fuel that can drive profitable growth and stronger brands."
Conagra fired some employees, restructured operations at all levels to step up efficiency, got rid of some brands through spinoffs and divestitures, and increased its focus on promising markets by selectively acquiring new brands.
In December 2019, Conagra had reported year-over-year growth of 66% in net income, 1.6% in organic sales, 18% in net sales, and segment growth as high as 28.8% (for its frozen and refrigerated business) for the fiscal Q2 2020 that ended Nov. 30. While the company credited The Conagra Way for strong results, this growth happened in a favorable economy with no major roadblocks. The coronavirus outbreak this year, however, provided a more demanding test.
Beating analyst estimates and making it count
The battering that COVID-19 inflicted on the U.S. and global economies stress-tested Conagra's new business model. For Q1 2021, ending Aug. 30, the company reported a 15% jump in organic net sales and a 12.1% lift in overall sales. Adjusted EPS came in at $0.70, meaning quarterly EPS jumped 62.8% year over year. Adjusted operating margin stood at 20.2%, a rise of 450 basis points.
These results came in ahead of Wall Street consensus forecasts, delivering several positive surprises. According to data collected by Zacks Equity Research, adjusted EPS was 22.8% above average analyst predictions of $0.57, while net revenue exceeded the consensus of $2.6 billion by approximately 2.9%. Conagra's guidance foresees a slight deceleration in gains for the current quarter (Q2) but still calls for 6% to 8% organic sales growth, and an adjusted operating margin of roughly 18% to 18.5%. Adjusted EPS could clock in anywhere from $0.70 to $0.74.
Building on the company's success to make its stock even more attractive to investors, Conagra's board raised its dividend by 29%, to $1.10 per share annually ($0.275 quarterly), with the first increased dividend payable Dec. 2. During the Q1 2021 conference call, a Bank of America analyst asked whether Conagra's growth is now at a level where it can grow the dividend consistently. He also asked why Conagra felt confident enough to raise its dividend so sharply (by nearly a third), yet didn't provide full-year guidance for fiscal 2020 -- a cogent question for investors curious about the dividend's sustainability.
Digging deeper into the data for answers, here are three takeaways from Conagra's recently ended quarter and forward outlook that investors in consumer staples stocks might want to consider:
1. Conagra is deleveraging.
The company is using its bumper crop of revenue and liquidity to rapidly pay down its debt. Its deleveraging was already making good progress as of May 21, when it had reduced debt by $1.8 billion since a key 2018 acquisition. At that point in time, it expected to reach a net leverage ratio of 3.5 times to 3.6 times by the end of fiscal 2021.
But the deleveraging appears to be ahead of schedule, with the target ratio now expected to be reached by the end of the third quarter of fiscal 2021, a quarter ahead of May's projection.
Reaching a lower leverage ratio is potentially important for Conagra's ability to deliver long-term growth. Less leverage means more liquidity for other purposes, such as strategic acquisitions, broadening the company's flexibility, and options in the future. CFO Dave Marberger said during the earnings call that "our cash flow, our deleveraging cadence are ahead of expectations," noting this contributed to the dividend hike because of the board's confidence in "the structurally higher earnings power for the company."
2. The company is investing in its business.
With both COVID-19 and the benefits of The Conagra Way strengthening Conagra's cash flow and the slashing of debt noted above, the company has the money to reinvest in successful parts of its own business. While it has trimmed unnecessary costs in just about every department and notably reduced its selling, general, and administrative expense, capital expenditure (capex) has risen 36%, to $39 million.
The capex spend is being directed toward building capacity, improving the speed and efficiency of the supply chain, and growing brands through various means, including marketing, Marberger said. The capacity increases helped supermarkets and other stores keep their inventories filled through the several waves of panic buying during the pandemic's height and translated into strong, steady revenue growth.
3. It's getting with the times through e-commerce.
One particular kind of investment in the business made possible by the convergence of Conagra's improved strategic nimbleness and economic circumstances is the company's e-commerce development. Connolly says that Conagra's e-commerce performance was ahead of those of peers in the packaged food industry for the last five consecutive quarters.
He said the company's ongoing focus on improving e-commerce is effective since "speed in supporting the business is very important because it enables you to build a beachhead in the e-tailing universe that helps us fuel future purchases." He pointed out that increased customer loyalty was the result of the business' speed, flexibility, and e-commerce.
Is Conagra's dividend hike risky or rewarding?
With all these facets of Conagra's performance in mind, is the company sticking its neck out with its dividend boost, or is there a solid reason for the increase that investors can potentially bank on? While caution is always wise amid the uncertainty caused by the pandemic, the board's decision to rapidly increase the dividend appears justified by actual results and astute decision-making.
Deleveraging, well-directed capex investment, and e-commerce improvements all show that The Conagra Way appears to be producing an economically efficient enterprise. You could certainly do worse than considering this company for your portfolio.