EUR 850.00 For Business Accounts Only

Morningstar | Conagra's Focus on Innovation and Brand Investments Support Solid 3Q Volume Performance

Narrow-moat Conagra's shares were up around 13% on strong third-quarter results, with organic sales up nearly 2%, including a 1.2% contribution from price/mix, and adjusted operating margin expanding 130 basis points to above 16%. Retail sales for the legacy Conagra business, excluding the Pinnacle acquisition, grew nearly 3% on a two-year stacked basis, marking the second quarter in a row that this metric was positive. This performance tracks in line with our longer-term outlook, which calls for slightly above 1% organic sales growth, with balanced contributions from volume and price/mix, after fiscal 2019 and operating margin hovering in the midteens. As such, we aren't expecting a substantial change to our $34.50 fair value estimate as we incorporate these results, and we think shares offer an attractive entry point for investors, even at current levels.

The highlight of the quarter was impressive organic volume performance in the grocery and snacks (32% of sales, up 2%) and refrigerated and frozen (26% of sales, up more than 3%) segments, following mid-single-digit average volume declines between fiscal 2016 and 2018. The snacks business accelerated, with retail sales up nearly 8% over the prior-year period, lifted by high-single-digit increases in popcorn and meat snacks. We attribute these gains to the firm's renewed focus on stronger, faster-moving items. As evidence, base sales velocity for snacks was up more than 9% in the third quarter, despite a 1.5% decline in total points of distribution. Performance in the refrigerated and frozen business was propped up by the frozen portfolio, which posted a 10% increase in retail sales, 5% increase in distribution, and 8% increase in base sales velocity, all on a two-year stacked basis. Frozen single-serve meals remain especially strong, with retail sales, excluding Pinnacle, averaging low-double-digit growth over the trailing 12 months, versus below 3% growth for the category.

We were also pleased that profitability strengthened despite headwinds from the Pinnacle acquisition (with Pinnacle's gross margin standing at just 26% during the quarter versus nearly 30% for Conagra's legacy business, due to increased investments behind its business and unfavorable mix) and ongoing input cost inflation. We attribute this to management's commitment to value over volume, that is, bringing value-added innovation to market while trimming slower-turning and lower-margin products from its brand set. We contend this strategy will continue to bolster performance over the long run, as consumers should be more willing to pay up for new products with value-added innovation (strengthening price/mix). Further, we posit that higher-quality products on shelves will shore up the entrenched retail relationships that underpin the firm's competitive edge.

Management expects to exceed its targeted cost synergies ($215 million) from the Pinnacle deal, though it hasn’t yet quantified a revised amount. While a greater degree of cost savings may create additional upside to our forecast, we don't expect the full amount of these savings to flow to the firm's bottom line. Instead, we surmise these efforts will free up funds for Conagra to reinforce investments in its portfolio, supporting organic top-line growth in the years ahead. Our confidence that management will maintain adequate levels of support in its brand set was bolstered by management's commentary during the earnings call that it will not "cut [its] way to prosperity." In this context, we expect the firm's combined spending on marketing and research development to remain around 4% of sales over our forecast (importantly, we note this does not include trade/retailer investments), which is comparable to historical levels.