ConAgra to Profit from Cheaper Food

04/12/2011 4:12 pm EST

Focus: STOCKS

Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

The giant food processor will reap rich rewards if grain prices extend their recent slide, writes Taesik Yoon of Forbes Growth Investor.

ConAgra Foods (CAG) is a leading North American food company. The company pays a generous dividend that currently yields 3.9% annually.

Coupled with the defensive nature of food companies, ConAgra shares should hold up better than most if the markets take a turn for the worse. At the same time, the benefits of recent pricing actions and higher volume will likely help lift profit margins, if economic conditions continue to improve.

The company’s Consumer Foods segment, which is responsible for approximately two-thirds of annual sales, makes a wide range of foods sold primarily through retail channels.

Products include frozen, refrigerated and shelf-stable meals, entrees, condiments, sides, snacks, and desserts marketed under well-known brands such as Banquet, Blue Bonnet, Chef Boyardee, Egg Beaters, Healthy Choice, Hebrew National, Hunt’s, Marie Callender’s, Orville Redenbacher’s, PAM, Peter Pan, Slim Jim, Reddiwip, and Wesson.

The company’s Commercial Foods segment, which generates the other third of sales, supplies specialty potato products, milled-grain ingredients, various vegetable products, and seasonings, blends, and flavors to foodservice, food manufacturing, and industrial customers.

Hit by Rising Materials Prices
Because of the mature and relatively inelastic (in other words, not very price-sensitive) nature of the food industry, CAG’s operations tend to be fairly stable. However, over the past year, the company has had to deal with a sharp rise in the price of key raw materials such as sugar, nearly all grains, and livestock.

Yoon Chart 1

This resulted in margin pressure and lower earnings through much of fiscal 2011 (which ends this month.) As a result, net sales in the first three quarters of the year grew 1.3% year-over-year to $9.13 billion, but adjusted earnings from continuing operations fell 3.7% to $1.29 per share.

NEXT: Why Things Are Looking Up

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Why Things Are Looking Up
Buoyed by stable volume in Consumer Foods, contributions from acquisitions, and higher volume and selling prices in Commercial Foods, operating results proved stronger than expected in its most recent quarter.

Third-quarter net sales climbed 4.1% from the prior year to $3.15 billion. The adjusted operating margin, which excludes restructuring charges, gains on asset sales, and other special items, expanded 69 basis points to 10.32%. Adjusted net income increased 8.9% to $214.8 million.

Benefiting from a lower share count, earnings per share climbed 13.6%, to 50 cents. This was 4 cents ahead of expectations.

ConAgra expects fourth-quarter earnings to be significantly above the 39 cents per share earned the prior year. This indicates that its recent earnings growth will continue.

Furthermore, while guidance for fiscal 2012 has yet to be finalized, the current consensus estimate calls for a 7% rise in adjusted earnings per share over the expected fiscal 2011 level. While this growth rate may not seem all that impressive, it represents a vast improvement over what will likely be earnings per share growth of less than 2% for fiscal 2011.

Yoon Chart 2

Of course, higher commodity prices could mitigate some of this growth. But we believe this risk is priced into the stock, which trades at a reasonable 13 times its fiscal 2012 estimate.

We also want to note that the prices of key commodities such as sugar, corn, oats, rice, and wheat are all well off their January/February highs. A continuation in this trend would further add to earnings growth in the coming fiscal year.

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