Investors in food company ConAgra Foods (NYSE:CAG) must have breathed a sigh of relief over the company's latest earnings results. They weren't particularly good, but the company has had a series of issues over the past year. In other words, any results that don't indicate any more deterioration will immediately switch investors' focus to how cheap the stock is compared to peers like General Mills and Kraft Foods. Is it now time to see ConAgra as the value play in the sector?
Going into its third-quarter results, ConAgra was reeling from a number of issues, covered in detail in a recent article. Unfortunately, ConAgra had difficulties in all three of its segments (consumer foods, commercial foods, and private brands), while its acquisition of Ralcorp has also disappointed, and the regulatory review process overshadowed the creation of its Ardent Mills joint venture with Cargill and CHS.
A quick look at the relative importance of its three segments reveals the importance of its consumer foods division.
Segmental operating profit only increased 3.6% in the third quarter, with consumer foods operating profit rising a paltry 0.6% (sales were down 3.5%) and commercial foods operating profit down 12.2% (sales down 0.7%). These figures are on an "as reported" basis, with the private brands' results not really comparable because of the Ralcorp acquisition.
With that said, there is a case for ConAgra being relatively attractive in its sector. It's on a forward P/E ratio of nearly 13 times earnings to May 2015, compared to General Mills' equivalent of 16.6 times, and Kraft Foods' forward P/E ratio of more than 16 times earnings to December 2015.
It's time to look more closely at ConAgra.
Running down ConAgra's checklist
First, regarding Ardent Mills, management reiterated its expectation that the deal would close "in the second quarter of this calendar year."
Second, its Lamb Weston segment (frozen potato products within its commercial food segment) took a hit this year from the loss of a contract with a major customer, and a relatively poor-quality potato crop. The effects can be seen in the segment operating profit declines discussed above. On a more positive note, this year's potato crop is unlikely to be as bad as last year's. Moreover, since the lost contract affected results in 2014, ConAgra will have a easier comparison in 2015 as it starts to build sales with new customers.
The third issue is the difficulties with the Ralcorp acquisition. Although Ralcorp's activities have been integrated across all three segments, it's really the private-brand business that matters. ConAgra has had some significant pricing issues with Ralcorp's products, and according to management on the conference call, there are likely to be short-term risks:
We continue to work to stabilize the base business and our efforts to stabilize have included price concessions we have had to make this fiscal year to prevent further volume issues. Those concessions mean that the margins for the Private Brand segment will continue to be challenged for the next several quarters.
On a more positive note, cost synergies are running "slightly ahead" of its $30 million target, and long term there is an obvious opportunity to reduce costs by merging Ralcorp's and ConAgra's existing private-brand operations. In fact, ConAgra aims to achieve $300 million in cost savings by the end of 2017. To put this into context, ConAgra is forecast to achieve $17.7 billion in sales in 2014.
In a sense, ConAgra is forced to move into private-label brands, because this is where the consumer and grocer are shifting. For example, Treehouse Foods is more of a pure private-label play, and it recently cited industry data indicating that grocers' private-label volume gains were up 2.7%, while the mass merchant channel lost 6%. This sort of commentary from Treehouse Foods indicates the need for ConAgra to adjust to market shifts.
Wal-Mart represented 17% of ConAgra's sales in 2013, and given the company's expansion in the grocery category and its plan to invest more in small stores, which are likely to have a relatively high percentage of groceries, ConAgra has an opportunity to increase sales in its private brands and consumer foods segments.
The consumer segment's problems seem to be focused on its Healthy Choice, Chef Boyardee, and Orville Redenbacher brands. ConAgra's management has reacted to weakness by making product and packaging initiatives in order to try to turn performance around. However, the proof of the pudding is in the eating, and it's here where Foolish investors really can do their own research on the brands' relevance and appeal to consumers.
The bottom line
There is no doubt ConAgra's valuation is cheaper than that of Kraft Foods or General Mills, but the company has underperformed and faces short-term challenges, particularly with integrating its Ralcorp acquisition. However, the Ralcorp deal makes sense, and ConAgra is likely to see better conditions in its commercial foods segment next year.