Sunday, December 23, 2012

Campbell Soup Earnings Analysis

What to do with Campbell Soup (NYSE: CPB)?  On the one hand, it’s a company serving up mediocre growth in organic revenue and earnings, but on the other, it is exactly the kind of relatively high yield defensive stock that the market is in love with right now. The bias inherent in the latter argument is likely to stay as long as US Government bond yields remain at depressed levels and money managers construct proxy equity portfolios for ‘safe’ assets.  But how safe is Campbell Soup?

A Crowded Trade

Frankly, I think it is a crowded trade right now and should a stronger US recovery cause bond yields to rise, then this type of stock could suffer. It is a similar sort of argument with food stocks like its rival H.J. Heinz (NYSE: HNZ) or ConAgra Foods (NYSE: CAG). Heinz was featured in an article linked here and, although its recent results were superficially strong, I have some concerns about the long term sustainability of its tax rate and its underlying earnings growth. ConAgra is arguably more attractive because it has a bit more growth and a collection of value brands with which it can benefit from consumers trading down.

With Campbell the question is how can it generate growth within a difficult trading environment?

Soup Kitchens

Okay it’s not quite that bad yet, but there is no doubt that the mass US consumer market is suffering. As a consequence it is changing its purchasing habits in ways which are affecting Campbell’s revenues. I’ve identified the following factors

  • Trading down to cheaper alternatives
  • Shopping at alternate sales channels like discount stores
  • Becoming highly aware and responsive of promotions and price reductions

These issues disrupting how food companies traditionally generate revenues. For example, even a private label manufacturer like Treehouse Foods (NYSE: THS) has had great difficulties this year. Its value offering is the sort of thing that should be flourishing but its traditional sales channels are being eroded in favor of consumers doing more grocery shopping at stores like Dollar General (NYSE: DG), Dollar Tree or Family Dollar. Treehouse has had to deal with a significant realignment in its end markets as its traditional customers lose footfall and sales to the discount stores. As for the dollar stores themselves, there are some signs of slowing growth in these companies but it is not due to a reversal of shopping behavior and more about how they are dealing with the pressures of their aggressive new store rollout plans.

Campbell’s Latest Results?

A quick look at how Campbell performed in its latest set of results.

I haven’t included earnings growth for the Bolthouse acquisition because they were not broken out from the overall ‘Bolthouse and Foodservice’ numbers.

And to put these segment growth numbers into perspective, here is how Campbell generated its earnings in the quarter.

First, the overall sales growth of 8% was largely due to the Bolthouse acquisition whereas organic sales growth was a miserable 1%.

The good news is that the turnaround in the core US simple meals segment appears to be on track. The bad news is that a large part of it appears to be due to movements in retailers’ inventory which will be corrected in the next quarter. Indeed Campbell confirmed that next quarter’s EPS would be likely to be lower than the full year guidance rate. Given that that guidance is only for 3-5% adjusted EPS growth, it suggests a tough quarter coming up.

Moreover, the sales growth in soups (US Simple Meals) has been driven by product innovation; new product launches and associated marketing. These things cost money and they also cost margin.

Gross margins declined in the quarter to 37% from 39.5% last year and, even with adjusting for the margin dilutive Bolthouse numbers, they were still down to 37.9%.

Global Baking & Snacks sales increased 1% but it took a 3% hot from increased promotions spending in order to generate it. This is somewhat of a concern because categories like snacks are showing strength for the likes of Kraft. Organic sales actually increased 2% in International Simple Meals & Beverages and gross margin gains were good. I suspect this is due to higher sales in Asia Pacific relative to Europe. US Beverages remain a challenged business as consumers continue their trading down efforts. Unfortunately for Campbell this means they are moving away from Campbell’s juice products.

Where Next For Campbell Soup?

If you put the moving parts together you have a company driving sales growth by acquisition. Organic sales growth isn’t great and there is going to be a correction in growth in soup following previously favorable customer inventory movements. The other segments are hardly performing well and even with the Bolthouse acquisition adjusted EPS growth is forecast in low single digits.

It isn’t impressive stuff and reducing marketing spending on soup after launching a lot of new products can appear like an attempt to grab some margin for past investments. I’m not sure that in this environment it will work. I’m also not sure that paying 15x earnings for a low growth business with business segments facing severe challenges makes sense right now. In my view there is better value out there.

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