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Morningstar | Cost Saves Simmer at Campbell Soup in 3Q, but Competitive Headwinds Persist; Shares Still Attractive

On the surface, Campbell’s third quarter might be viewed as uninspiring, as organic sales held flat at $2.2 billion and adjusted gross margins eroded 210 basis points (excluding the fresh business, which is being divested) to 33.4%. The profit contraction reflects last year’s acquisition of Snyder’s-Lance (which constrained margins by 170 basis points) as well as higher input costs (which proved to be a 350-basis-point headwind), the impact of which was partially offset by cost saves and productivity improvements (a 210-basis-point benefit) and higher prices (a 110-basis-point positive contributor). However, this performance exceeded its outlook and contributed to a modest bump in its fiscal 2019 EPS guidance to $2.50-$2.55 (from $2.45-$2.53 prior). With results tracking our forecast, though, we don’t anticipate material changes to our $45.50 fair value estimate or long-term outlook (calling for 2%-3% organic sales growth and high-teens operating margins). Even after accounting for the high-single-digit uptick in shares, we still view the stock as modestly undervalued.

While details have been sparse thus far, we anticipate further visibility into the roadmap CEO Mark Clouse intends to embark upon at the firm’s investor event June 13. In our view, his overarching strategy will likely be anchored in adequately investing behind its brands while maintaining a disciplined bent toward costs, which we perceive as prudent. As part of this, we believe Campbell’s efforts to extract $650 million in costs by fiscal 2022, which equates to 8% of cost of goods sold and operating expenses (excluding depreciation and amortization), will prove attainable. However, we think a portion of any efficiency gains realized will fund additional brand spend (with our forecast calling for more than 7% of sales annually allocated toward research, development, and marketing) and support the brand intangible asset (its entrenched retail relationships) that underlies its wide moat.

From a segment perspective, meals and beverages continues to succumb to competitive angst, with sales flat relative to a year ago (including flat soup sales), hindered by lagging sales of V8 beverages and Prego pasta sauce. However, sales within the firm’s global biscuits and snacking operations edged up 1%, on top of 1% growth in last year’s third quarter, led by Goldfish crackers and Pepperidge Farm cookies (which boasted its 18th consecutive quarter of organic sales growth). And we believe that Campbell’s on-trend snacking operations are poised for further gains as it integrates the Snyder’s-Lance brands, with our outlook calling 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. We surmise 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 consumers’ penchant for convenient, healthy fare.

Management has failed to entertain the idea that further divestitures will be in the cards, but we believe its prior decision to part ways with its fresh and international operations (the intent of which was announced in August 2018), representing $2.1 billion in fiscal 2018 sales (about one fifth of its consolidated base), should enable it to concentrate its resources to steady its business on its home turf, which has been struggling at the hand of intense competitive angst. Beyond affording it the opportunity to operate with a more focused portfolio, we are also encouraged by management’s intent to direct any proceeds to the paydown of debt, with leverage sitting at nearly 6 times at the end of fiscal 2018.