EUR 850.00 For Business Accounts Only

Morningstar | Campbell Reverses Course by Opting to Slim Down as its Recipe for Sustainable Sales and Profits

Campbell’s sluggish year-end (a 3% organic sales decline, a 560-basis-point degradation in adjusted gross margins to 30.6%, and a 420-basis-point erosion in adjusted operating margins to 12.7%) was overshadowed by the conclusions of its strategic review. As such, the firm announced intentions to sell its fresh and international operations (including the Kelsen and Arnott’s brands), which in aggregate generated $2.1 billion in fiscal 2018 sales (about one fifth of its consolidated base). We see the merits in parting ways with both, as Campbell lacks the scale and reach internationally to profitability win with local consumers. Further, while we initially surmised efforts to bolster its position in natural and organics was a prudent means by which to diversify away from the stagnant center store, the firm has been challenged by the dynamics surrounding carrot farming, which expanded Campbell beyond its wheelhouse. In this vein, we perceive these select asset sales as prudent, particularly as any proceeds are to be directed toward debt reduction, which soared to nearly $8 billion following the Synder’s-Lance deal (equating to debt/adjusted EBITDA of 4-5 times).

Beyond portfolio changes, Campbell also aims to up the ante on its cost savings, now targeting $650 million by fiscal 2022 (up from $500 million by fiscal 2020 prior), or 8% of cost of goods sold and operating expenses (excluding depreciation and amortization), in line with the 6%-9% its peers target, which we think is attainable. Finally, management updated long-term expectations for sales growth (now 1%-2% annually) and adjusted EBIT growth (4%-6%). We intend to trim our sales outlook, which currently calls for low-double-digit growth in fiscal 2019 and a shade above 2% each year through fiscal 2028, but don't anticipate material changes to our profit expectations which aligns with the firm’s revised forecast. This will likely result in a low- to mid-single-digit cut to our $48.50 fair value estimate.

Despite the stumbles that have ensued with its integration of Bolthouse Farms, we don’t believe the recent tie-up with Synder’s-Lance will face the same fate. In our view, snacking is a business that Campbell knows and understands well (particularly with its Pepperidge Farms and Goldfish brands), and we expect that it will be able to leverage this insight and distribution clout, enabling it to take advantage of consumer’s penchant for convenient, healthy fare. However, we also posit the combined entity could bolster the spending behind its brand mix as a means to differentiate its fare in this intensely competitive space and ultimately support its competitive edge. This underlies our outlook for Campbell to chalk up 2%-3% annual segment top-line gains longer term in a space that stands to account for about half of its mix.

While much talk has centered on whether Campbell should pursue an outright sale (particularly as it has been under pressure from activist investor Danial Loeb over the past few months), we were skeptical such a path would be in the cards. Campbell is a controlled company, with the Dorrance family (direct descendants of the man who invented the process by which wet soup is turned into condensed soup) owning about 40% of the outstanding shares. Further, two members of the Dorrance family sit on the 12-person board. And while the firm repeatedly emphasized its focus on continuing to analyze further opportunities to enhance the value of the business, we believe the board is likely to allow the current course to play out before considering additional transformational activities.

Beyond its organizational changes, the firm is also still on the hunt for a permanent replacement for its former CEO Denise Morrison, who stepped down abruptly in May; since that time Keith McLoughlin, a board member who previously was CEO at Electrolux has served as CEO in an interim capacity. While we don’t deny that fresh insights could be exactly would Campbell Soup needs as its works to steady its course, we see current-COO Luca Mignini as the most likely candidate to fill the top spot. From our vantage point, over his five years at the organization Mignini has gained significant experience running the firm’s international and global biscuits and snacking operations (the latter of which has been a relative bright spot within its portfolio). Further, we believe that recent executive appointments across its business (including a new head of marketing and leader for the meals and beverages business) could infuse its operations with added perspective that might have been lacking in the past. In this light, we don’t intend to alter our standard stewardship rating.