Friday, August 24, 2012

ConAgra Offers High Yield and Defensive Growth

Investors looking for a safe haven yield play should take a look at ConAgra Foods Inc (NYSE: CAG). It is not the sexiest growth story out there but the company generates large amounts of cash flow which amply support a near 4% yield. In addition, it has a some value and private label brands which benefit from a sluggish economy. The consumer focus is probably a good thing (people eating out less) and with commodity costs looking like they are set to moderate, it could see some margin expansion.

Food Companies Riding the StormIt's been a tricky time for the food companies. As companies like General Mills (NYSE: GIS) have noted commodity costs have been rising at the same time as consumers are retrenched in a value conscious behavior. Some companies like Kellogg (NYSE: K) have tried to pass through costs in the form of higher pricing but have been met with a raft of resistance. Price sensitivity appears to have increased for as long as the economy has remained weak.

As a consequence, shoppers are more inclined to buy groceries from the dollar stores and trading down has been a necessity not an option. In addition, the type of buying has changed. Companies like Heinz (NYSE: HNZ) have seen shoppers looking for smaller portion sizes and it has had to adjust its offerings accordingly. Shoppers are more price sensitive but this doesn't mean that quality can be sacrificed. For example, Campbell Soup (NYSE: CPB) has seen a number of changes to its product line up with a view to innovating and cutting costs. None of which seem to be particularly successful.

Putting these issues together suggests that the food companies may not quite be the kind of defensive play that they would have been in the past. They find themselves squeezed on both sides. ConAgra has not been immune and it has seen volumes falling in certain brands as a result of price increases.
However things are changing and, I think ConAgra has some reasons for optimism.


Better Times Ahead for ConAgra?
Commodity prices are falling for ConAgra. In fact, in the first three quarters of the year it reported an 11% increase whilst the fourth quarter saw only a 6% increase. Meanwhile, prices have been pushed through at the largest volume business in the consumer foods segment, namely Banquet. This did cause an inevitable fall in volumes, but overall the consumer foods segment (63% of sales) saw a 6% rise in sales with a 7% rise in adjusted operating profits.

Of particular interest in the consumer foods segment is the strength of its private label brands business which specializes in nutrition and snack bars for store-owned brands. This enables it to leverage a value orientated offering into the sales mix. I was encouraged by the management talking about the expansion opportunities here.
Furthermore, ConAgra has a few key brands in some attractive categories. Healthy Choice, Libby's, Marie Callender and Lightlife all saw sales growth in the quarter. Meanwhile other consumer brands, like Banquet, saw volume declines (organic volume sales were down 5% in the segment) but sales increases due to pricing.

It was a similar story with the commercial foods segment (37% of sales) which reported a 6.8% increase in sales with a 7.5% increase in operating profits despite having to deal with higher commodity costs. Of particular note is the Lamb Weston brand, of which, management is claiming good sales momentum particularly within emerging markets. It strikes me that potatoes are a pretty recession resistant food and as a consequence sales growth has been consistent in this segment. Management seems very confident that growth will remain strong for Lamb Weston.


Is ConAgra Worth Buying?
Investors looking for yield and stability will like ConAgra. It only offers single digit growth prospects but the underlying free cash flow suggests that there is room to grow the already-healthy dividend.

ConAgra ($m)May 2009May 2010May 2011May 2012
Free Cash Flow (FCF)557960886713
Dividend (D)348347375389
D/FCF62%36%42%55%
Despite increased pension contributions (which are made to fund future requirements) of $326m in 2012, ConAgra generated good free cash flow again and given continued growth in the business, there is ample scope for dividend increases. In addition, the company has been active in making acquisitions which have tended to be in the faster growing snacks and alternative breakfast areas of the food industry. There is plenty of room for more of the same, or perhaps a timely expansion of its private-label offering.

I think ConAgra offers a good mix of steady growth and yield particularly for risk adverse investors fearing an uncertain economy.