Portfolio Strategy

June 7, 2019

The Long and Short

Campbell Soup unlikely to hold gains vs ConAgra

Meredith Contente | June 7, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Campbell Soup’s fiscal 3Q sales beat estimates and adjusted EPS beat consensus, but underlying growth trends are not as strong as headlines suggest. Despite this, CPB 30-year bonds tightened roughly 15 bp after earnings, while its food and beverage peers were roughly 7 bp tighter on the day. Prior to CPB’s results, ConAgra Brands Inc. (CAG) bonds had been trading roughly 10 bp through CPB, whereas CPB spreads are now trading flat to CAG in both the 10-year and 30-year parts of the curve. CAG’s results on 6/27/19 could be the catalyst for spreads to push through CPB again.

Earnings overview

While CPB’s fiscal 3Q sales of $2.39 billion beat estimates of $2.36 billion and adjusted EPS of $0.56 beat consensus of $0.47, underlying growth trends are not as strong as headlines suggest. Organic net sales were flat for the quarter with meals and beverages flat to slightly down and global biscuits and snacks up 1%. The growth in the snacks business was largely driven by Pepperidge Farm which posted its 18th consecutive quarter of organic sales growth.

Adjusted EBIT was down 2% in the quarter due to increased administrative costs and gross margin pressure due to inflation. Operating earnings for meals/beverages were down 5% year-over-year, reflecting continued weakness in the soup business. CPB management noted that in-market soup consumption was down 2.6%. While an improvement from the first half of the year which was down 5.5%, management provided no expectations for when they expect the trend to return to positive territory.  Furthermore, CPB’s soup market share continues to decline. While still the largest player with a 57.8% market share, the company lost 1.6 percentage points of share year-to-date with 1.3 percentage points going to private label and 0.3 percent points going to other brands. This follows a 2.4 percentage point market share loss in 2018.  With meals and beverages the higher EBITDA margin business line (20.2% versus 12.0% for global biscuits and snacks in 3Q), the continued operating declines in this unit has caused the combined EBITDA margin to decline.  For the quarter, CPB’s EBITDA was 19.5%, down 80 bp year-over-year.

Good progress on cost savings target

 Management has targeted $945 million of cost savings by 2022, which includes synergies from the Snyder’s-Lance acquisition.  During the quarter, CPB delivered on $55 million of savings, bringing year to date savings up to $150 million.  This is ahead of previous guidance of $120 million for the full year.  That said, CPB now expects to deliver on $180 million of savings for the year which could help to offset cost headwinds.

Further debt reduction expected

It’s been slightly over a year since CPB closed on the Synder’s-Lance acquisition (3/28/19).  Since the close, CPB has repaid $563 million of debt.  CPB ended the quarter with total debt/EBITDA of 4.9x, down from over 5.0x at the close.  Management expects proceeds from the CPB Fresh sale to be approximately $565 million and has slated them for debt reduction. Should all the proceeds be used to reduce debt, we estimate that CPB could bring leverage down to the 4.6x area.  The company is also actively trying to sell its International biscuit brand Arnott’s, another key component of it debt reduction plan.

 Full year guidance revised

Positive growth headlines seemed to focus on management’s revision to EPS for the full year, however the guidance revisions were largely due to the pending CPB Fresh sale which is expected to close by 7/31/19.  Adjusted EPS was revised to the $2.50-$2.55 range, up from previous guidance of $2.45-$2.53.  Full year net sales were revised downward with CPB now expecting net sales to be in the $9.075 to $9.125 billion range, down from $9.975-$10.1 billion.  Management also revised the low end of its adjusted EBIT range from $1.37 to $1.39 billion.  The high end of the range was left unchanged at $1.41 billion.  We view this to be the most positive piece of the guidance revision.

Relative  value

CPB 30-year bonds tightened roughly 15 bp after earnings while its food and beverage peers were roughly 7 bp tighter on the day.  The tightening in the long end pushed CPB 2048 bonds roughly 10 bp through Conagra Brands Inc. (CAG) 2048 bonds.  However, following earnings, headlines that Mondelez was pulling out of talks to purchase Arnott’s emerged. CPB spreads widened on the news and are now trading flat to CAG in both the 10-year and 30-year parts of the curve.

While CAG is also digesting its acquisition of Pinnacle (which closed on 10/26/18), they have stabilized core CAG brands and actually posted solid organic growth of roughly 2% in the last quarter.  The stability of its core brands allows management to actively focus on integration as well as fix executional issues at the core Pinnacle brands (Birds Eye, Duncan Hines and Wish-bone).  CAG is currently levered roughly 4.9x, and further debt reduction via non-core asset sales and strong cash flow should bring leverage to the 4.5-4.6x area by calendar year end. Comparatively, CAG has better organic growth momentum and their pace of debt reduction since the close of Pinnacle has been faster than CPB’s.  CAG management has noted that they don’t need to rely on asset sales to hit their leverage target but could use asset sales to speed up the pace of deleveraging. Prior to CPB’s results, CAG had been trading roughly 10 bp through CPB. CAG’s results on 6/27/19 could be the catalyst for spreads to push through CPB again.

Meredith Contente
1 (646) 776-7753
mcontente@apsec.com

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