Conagra’s Brands Are Performing Well Despite Inflation and Supply Chain Challenges

Business Strategy & Outlook

When CEO Sean Connolly was brought in to turn around a struggling Conagra in 2015, he implemented a new brand building strategy referred to as the Conagra Way. The process calls for using data to identify product attributes that are driving growth and designing products to reflect those traits. The strategy also increases the productivity of marketing investments by shifting spend to the more efficient digital channel and to higher potential brands. In addition, the firm has significantly reshaped its portfolio inorganically, shedding non-branded or noncore businesses and acquiring brands that enhance the firm’s growth and/or profit margins. As a result, in recent years, sales have inflected from declines to growth, and from market share losses to modest gains. The pandemic, which resulted in four and a half years of incremental new buyers and saved the firm hundreds of millions of dollars in customer acquisition costs, will accelerate the benefits Conagra is reaping from these efforts, as many new consumers have been exposed to its new fare. Once the food retail market normalizes post-pandemic, the Conagra can realize 2% annual organic sales growth. In addition, Conagra has identified over $700 million in supply chain efficiencies, which should result in operating margins that exceed 18% over the long term, up from fiscal 2021’s 17.5% metric.

Despite these efforts, an enduring competitive advantage via its brand assets or entrenched retail relationships remains elusive. Conagra maintains many market-leading brands, which makes it an important partner to retailers. However, Conagra’s commitment to maintaining below-average investments in marketing (about 2.4% of revenue on average over the past three years compared with the 4.6% peer average) and research and development (0.5% of revenue compared with the 0.8% peer average) weakens the conviction that Conagra can maintain its preferred status with retailers over the next 10 years, as required for a narrow moat designation.

Financial Strengths

Conagra’s net debt/adjusted EBITDA averaged 2.7 times in the three years before the $10.9 billion Pinnacle Foods acquisition in fiscal 2019. After the deal, leverage reached 5.8 times in fiscal 2019, and the expected share repurchases and additional acquisitions will remain limited until leverage reaches 2.3 times in 2025. Over the next five years, the expected average interest coverage (EBITDA/interest expense) of 8 times, in line with the peer average. One cannot have concerns about the firm’s inability to meet its debt obligations, as cash flows are relatively stable. The model share repurchases increasing meaningfully in 2025 (assuming the absence of acquisitions), with Conagra buying back about 1%-3% of outstanding shares annually, which as a prudent use of cash when the shares trade below the assessment of intrinsic value. The firm repurchased a significant amount of shares in fiscal 2017 and 2018, but as they were trading above the estimate of intrinsic value, one cannot view the transactions as judicious uses of capital. Although Conagra will likely make acquisitions once it reduces debt, one cannot have modeled future transactions, given the uncertain timing and magnitude. Instead, the model excess cash flows being used to repurchase shares. Conagra resumed dividend growth in fiscal 2021, after foregoing increases following the Pinnacle acquisition, to focus on debt reduction. Conagra announced a further 20% increase in the quarterly dividend during fiscal 2022 to $0.3125, and the high-single-digit annual increases thereafter. Over the next 10 years, the Conagra’s payout ratio to range from mid-40% to low-50%. Finally, the firm to spend 3%-4% of revenue on capital expenditures on average each year.

Bulls Say

Conagra is utilizing a unique data-driven innovation approach, which has allowed many of its brands to gain market share.

After significant portfolio reshaping, now 64% of Conagra’s sales stem from the high growth categories of frozen foods and snacks.

Over $700 million in supply chain efficiencies and positive mix should facilitate about 100 basis points of operating margin expansion in the next 10 years to over 18%.

Company Description

Conagra Brands is a packaged food company that operates predominantly in the United States (over 90% of revenue and profits). It has a significant presence in the freezer aisle, with brands such as Marie Callender’s, Healthy Choice, Banquet, and Birds Eye. Other popular brands include Duncan Hines, Hunt’s, Slim Jim, Vlasic, Orville Redenbacher’s, Reddi-Wip, Wish-Bone and Chef Boyardee. While the majority of revenue is sold into the U.S. retail channel, 7% of fiscal 2021 sales were to the food-service channel, down from 11% in fiscal 2019 due to the pandemic.

(Source: Morningstar)

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