Investors in ConAgra Foods (NYSE:CAG) must wonder what on earth will come next. The company's update in February outlined a litany of problems that ran though its existing operations, through its acquired businesses, and even to the future formation of a joint venture. Value-seeking investors may ask whether these problems mark the trough of ConAgra's difficulties, and if the stock offers good value.
ConAgra's list of problems
Many of the company's problems don't indicate anything new, rather they show a failure to rectify ongoing issues. For example, in a previous article in July, readers learned of the three big risks associated with the stock. In short, ConAgra struggled to generate sales growth in its consumer-foods division. Moreover, its acquisition of private-label manufacturer Ralcorp produced results that came in below expectations. Finally, it lost a major customer from its Lamb Weston (potato operations) unit within its commercial-foods segment.
Fast forward to the recent February update and the company faces these issues:
- The performance of some of ConAgra's key brands in consumer foods continues to disappoint, particularly Orville Redenbachers, Healthy Choice, and Chef Boyardee.
- The issues at Ralcorp (particularly with pricing) are taking longer to fix, even though management continues to argue that they are near-term and fixable.
- The pace of margin recovery in the Lamb Weston business has proved slower than anticipated as ConAgra replaces volumes lost from a key contract.
- Bad weather affected the potato crop and ultimately profitability at Lamb Weston.
- As a result of ongoing regulatory review processes ConAgra's management now expects the Ardent Mills joint venture will be complete in the second calendar quarter of 2014.
All these events contributed to the company's decision to reduce its full-year 2014 diluted EPS guidance to $2.22-$2.25 from its previous outlook of $2.34-$2.38.
While management can do little about the weather or regulatory processes, the other issues do call ConAgra's management into question.
Four ways that ConAgra disappointed investors
First, management candidly admitted that they misunderstood the extent of the pricing issues across Ralcorp's categories. Gary Rodkin, on the recent conference call in February, said:
We did not fully appreciate the extent of the issues right away, and we have simply not been able to move fast enough to stabilize the business in the face of those executional problems. During this time of transition, we have had to make pricing concessions in bid situations to prevent further volume erosion, and that has affected margins.
Frankly, these sorts of issues show the nature of the private-label food manufacturing industry, as shareholders in Treehouse Foods (NYSE:THS) can attest. The industry remains volatile at the best of times, mainly because manufacturers always remain subject to the pricing and merchandising decisions of their retail customers.
Moreover, the current ultra-competitive grocery marketplace sales channels (where customers shop) constantly change in response to pricing. This makes predicting earnings very difficult for Treehouse and ConAgra's Ralcorp acquisition. Indeed, Treehouse has beat or missed analysts' estimates for at least the last four quarters. So if analysts find it hard to know where Treehouse is headed, why should ConAgra investors feel confident that Ralcorp's fortunes will turn around quickly?
Second, back in June 2013 ConAgra argued that Ralcorp had "short-term and fixable" problems. Fast forward to February, and the company still described the problems at Ralcorp as "near-term issues only" on the conference call.
Third, on the first-quarter conference call in September, management declared that it was "very confident" that it would make up for the loss of a Lamb Weston contract over the long-term. Again, ConAgra's management made an overly optimistic call.
Fourth, back on the fourth-quarter conference call in June 2013, ConAgra's management discussed the consumer-foods segment thus:
Many of our brands grew sales, shares and volumes. Along those lines, organic volumes increased 3%. This is an important turning point and a strong improvement
Unfortunately, a "turning point" didn't occur at all. In fact, ConAgra now expects volumes in its consumer foods segment to decline by 3%-4% in its second half, from a previous estimate of a 1%-2% decline. Furthermore, ConAgra's management explicitly recognized that it had to change its strategies with its key consumer brands.
Where next for ConAgra?
In conclusion, the company has much to do to convince investors that it can get back on track. Some of the company's issues have been unfortunate, but ConAgra's management has also been too optimistic about internal execution over the last year. Although it trades with a forward P/E ratio of just over 13 times earnings, cautious investors will want to see evidence that the company has started to resolve some of its ongoing issues.