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Morningstar | Conagra's 1Q Results Not Immune to Industrywide Challenges, but Long-Term Outlook Intact

Narrow-moat Conagra's first-quarter results largely aligned with our expectations, with organic sales up 1.2% (versus our full-year expectation of roughly 1%), driven entirely by price/mix, and operating margin contracting 40 basis points to 14.1% (our full-year outlook is a touch below 14%) as commodity cost inflation continues to weigh on packaged food firms. While we're encouraged by consistent improvements in pricing, with Conagra posting positive average unit price changes each quarter for more than two years, we still expect declining center-store traffic coupled with intense competition from the largest food companies as well as niche players to constrain top-line growth. However, we believe Conagra's efforts to differentiate and bring more modern, premium products to market should help sustain modest improvements in price/mix, averaging around 60 basis points over our forecast, excluding Pinnacle.

While the shares fell around 8% on the earnings announcement, we've already baked these challenging category dynamics into our longer-term outlook for low-single-digit organic growth and midteens average operating margin. As a result, we don't expect a material change to our $37 fair value estimate. We suggest investors wait for a slightly larger margin of safety.

The refrigerated and frozen segment (35% of sales) continued to recover during the quarter, posting 1.4% organic sales growth, including 50 basis points of volume growth. This suggests to us that the firm's efforts to revitalize core brands like Banquet and Marie Callender's are taking hold. As further evidence of improving momentum in the frozen category, average weekly total points of distribution increased 6%, marking the fourth quarter of sequential improvement. Also, we think the addition of Pinnacle Foods' brands (the acquisition is expected to close by the end of October) will shore up Conagra's positioning in the frozen aisle.

We maintain that Conagra will need to reinforce its investments behind its brands in order to prop up top-line growth amid ongoing competitive pressures. We expect its brand-related spending (advertising and research and development) to amount to more than 4% of sales over our forecast. This metric excludes the firm's retailer investments, which have been bolstered of late as Conagra has partnered with retailers to improve the positioning of its brands, including innovation in its shelving and displays. We contend that these actions will help Conagra maintain its entrenched position in these retailers' supply chains, which is a key factor underpinning our view of its competitive edge.