EUR 850.00 For Business Accounts Only

Morningstar | Conagra's Shares Slide on Weak 4Q Sales, but Innovation Should Bolster Long-Term Trajectory

Narrow-moat Conagra's fiscal 2019 results fell slightly short of our expectations, as profitability improvement (adjusted operating margin expanded 40 basis points to 15.4%, slightly above our 15.2% estimate) was largely offset by softer sales ($9.5 billion, versus our $9.6 billion estimate), leading to adjusted EPS of $2.01 (versus our $2.06 outlook). However, we see two reasons to remain optimistic about the firm's long-term trajectory. First, we continue to think Conagra's strong slate of innovation and brand-related investments will reinvigorate performance within its legacy business. As we detailed following the firm's investor day in April, management has increasingly focused on refreshing its core brands, driving premiumization within its portfolio, and expanding successful brands into adjacent product categories. We contend these efforts will support its top-line trajectory and margin profile (management's long-term algorithm incorporates adjusted operating margin expanding toward a high-teens level over the next few years, which we expect to occur at a slower pace) longer term.

Secondly, Pinnacle's performance appears to be stabilizing, with $1.7 billion in full-year sales matching our outlook, and we think management has been adequately responding to concerns around lackluster innovation and subsequently heightened promotional activity within its business (which first surfaced in December). Management is targeting $285 million in cost synergies (with $31 million realized in fiscal 2019), which should further free up funds to revitalize Pinnacle's brands. We intend to reassess our assumptions in light of these results but don't expect a large change to our $35.50 fair value estimate, as our pre-announcement estimates for fiscal 2020 fall within management's updated outlook for 1%-1.5% organic sales growth and $2.08-$2.18 in adjusted EPS. With a low double-digit percentage decline on the announcement, we continue to view shares as undervalued.

While retail sales for Pinnacle remain soft (declining 5.6% in the fourth quarter), we attribute this to the firm's strategy of prioritizing value-added innovation (supporting higher margins and increased velocities) rather than pursuing volume growth in isolation. As evidence, base sales velocities for Pinnacle remained strong in the fourth quarter, up 5.9% (or 12% on a two-year stacked basis), and Pinnacle's fiscal 2019 adjusted operating margin of 17.2% compared favorably with the 15.4% for the consolidated firm.

Still, we don't expect performance improvement to follow a linear path, as evidenced by lackluster top-line performance in the fourth quarter. While we were pleased to see incremental improvement in price/mix (up 0.5%), this was more than offset by a 1.2% decline in organic volumes. The grocery and snacks segment (34% of sales) was particularly weak, chalking up low-single-digit declines in both volume and price/mix in the fourth quarter. This was partly driven by softness in the Hunt's and Chef Boyardee brands, as higher prices coupled with increased promotional activity from competitors led to pronounced volume declines. While we note that the competitive environment remains intense, we believe management's "value over volume" strategy is prudent, and that it will be able to support pricing longer-term by bringing more innovative products (that consumers are willing to pay up for) to market. We note that the proportion of fare sold on promotion decreased around 6% between 2015 and 2018, bolstering our confidence in management's ability to execute this strategy.