Getting into the private-label business was a major mistake for ConAgra Foods (NYSE: CAG). Despite the growth of the white-label food industry, the consumer food products giant's $5 billion purchase of private-goods maker Ralcorp in 2013 never went anywhere, and CEO Sean Connolly finally threw in the towel, noting it was a "a suboptimal use" of the company's resources to expend the time and effort necessary to turn the business around. Better, he decided, for the company to cut its losses and focus on what works.
That means that soon, ConAgra will largely be just a brand consumer food company. It's spun off its milling operations in a complicated three-way deal that merged them with Horizon Milling, a joint venture of privately held Cargill and CHS (NYSE: CHS) (ConAgra relinquished control over day-to-day operations, but retained an ownership stake in the business), sold most of its Ralcorp private label assets to industry leader Treehouse Foods (NYSE: THS) for $2.7 billion, and is spinning off its Lamb Weston potato operations.
What will be left is a fine-tuned portfolio of name brand products that includes Chef Boyardee, Manwich, and Slim Jim. This new focus means ConAgra's stock has a good chance to rise in the future. Here are three reasons why.
1. Name brand goods are profitable.
The new consumer brands company, to be called Conagra Brands -- with a lower-case "a" -- will consist primarily of its consumer foods segment, which had about $7.2 billion in revenues in fiscal 2015. That was also the most profitable division, generating about two-thirds of the food products company's operating income.
Operating profits for the division expanded some 16% over the first six months of ConAgra's fiscal year, compared to 13% growth in its commercial foods business. It benefited from a favorable mix of prices and products, strong increased productivity from its cost-cutting measures, and lower commodity input costs, which more than offset the increases it experienced in marketing and the headwinds it faced from unfavorable currency exchange rates.
2. Slimming down will help it pay down debt
ConAgra has a heavy debt load that stood at more than $6.2 billion at the end of November, , even after it used proceeds from earlier transactions to pay its debt down. Conversely, its cash on hand was less than $100 million.It will be using the proceeds from the next deals to bring that down to a more manageable level. The private label sale, for example, will primarily be used for debt reduction, and ConAgra expects the transaction to result in a tax asset of approximately $1.6 billion, which it can use to offset future capital gains over the next five years.
The spinoff of Lamb Weston, however, seems curious, since it doesn't give the company access to a tax loss shield, and some analysts speculate it really may just be a means for ConAgra to attract bids for the unit.
3. The narrowed focus may help it improve valuation
Compared to rival General Mills (NYSE: GIS), ConAgra's valuation is depressed. Including Lamb Weston, ConAgra has operating margins of less than 15% over the first half of fiscal 2016 while General Mills enjoys margins north of 18%. The consumer foods division's margin, however, is above 16% and without the weight and drag of the commercial foods business or the private label operations, ConAgra should be able to boost its numbers closer to those of its rival.
A smaller ConAgra is a better ConAgra
Do one thing, but do it well seems to be the food product company's mantra these days. Or, as Warren Buffett might say: stick to your core competencies. With a CEO who oversaw the sale of Hillshire Brands to Tyson Foods and Jana Partners, an activist investor now on its board, ConAgra should be able to navigate the waters to higher growth from implementing a streamlined, cost-effective business.
After nearly a half year during which its stock traded in a fairly narrow range, the company now has a clear focus on its future, and investors may just be poised to reap the rewards of patience as ConAgra's shares rise.
Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.