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Morningstar | Campbell Ignites Change and Fuels Spend to Spice Up Its Sales Trajectory; Shares a Touch Undervalued

After just five months at the helm, wide-moat Campbell Soup’s new CEO Mark Clouse has laid out the recipe he plans to use as the firm works to steady its course. In a shift from the past, the firm no longer intends to place an outsize emphasis on extracting profits from its core soup lineup (starving the business of investment) nor does it aim to rely on acquisitions outside its core focus to bolster its trajectory (each of which were key tenets of former CEO Denise Morrison’s model during her seven years leading the charge). Rather, management’s updated playbook is anchored in driving profitable growth across its core meals, beverages, and snacking niches, which strikes us as prudent.

Further, building off its announcement in August 2018, management stressed its commitment to parting ways with its international operations (even though a sale has yet to be inked). When combined with the pending sale of the fresh business (which is to generate proceeds totaling $565 million), we believe these efforts position the firm to hone its resources on the highest return opportunities, while also lowering its debt load (which soared to more than 6 times following the tie-up with Snyder’s-Lance last year).

While orchestrating this change will likely prove out over a multi-year period, Campbell reiterated its long-term targets at its investor day in Camden, New Jersey, on June 13, calling for 1%-2% annual sales growth, 4%-6% adjusted EBIT growth, and 7%-9% adjusted EPS growth, each of which generally aligns with our forecast for the firm’s underlying operations. As such, we see little to warrant a material change to our $45.50 fair value estimate or long-term outlook (organic sales hovering around 2% annually and operating margins amounting to the high-teens). At less than a 10% discount to our valuation, we don’t view shares as offering a compelling value at present and would suggest investors await a more attractive risk/reward opportunity before building a position.

From our vantage point, righting Campbell’s ship starts with upping its game as it relates to innovation. Management was forthright that it has for years failed to bring on-trend, new products to market in a timely fashion (with product development cycles amounting to 18 months or more, far in excess of the mere weeks or months smaller, niche brands boast). However, CEO Clouse and vice president of research and development Craig Slavtcheff divulged a commitment to utilizing a dedicated team (versus one diffused across the organization) to drive these efforts, while also pursuing external partnerships to ensure its fare effectively aligns with evolving consumer trends (rather than just resting on its own expertise). In this vein, management intends to move away from large-scale launches to a “test and learn” approach whereby it will move to bringing a product to market in a select locale, assessing the consumer response, and adjusting the offering as necessary to more effectively win with consumers around the world. We view this as a prudent means to more nimbly respond to evolving consumer trends, targeting to cut its time to market in half. The initial fruits of these efforts have already been seen within its Pepperidge Farm arm, which boasts that the percentage of sales from new innovation over the past three years has improved from the low-teens to the high-teens (versus the meals and beverage operations, where new products have only constituted a mid- to high-single-digit percentage of sales). However, even value-added new products can fail if consumers are unaware, and as such, Campbell also aims to boost its advertising and consumer spend by 1-2 points by fiscal 2022. As a means to fund this added brand spend, we’re encouraged by Campbell’s aims 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). And in line with our thinking, management suggested its intent to funnel around half of these savings behind its brand mix (in the form of both R&D as well as marketing), supporting the intangible asset that underlies its wide economic moat. This aligns with our forecast calling for research, development, and marketing to edge up to 8% of sales over the next 10 years (or about $2.6 billion annually), above historical levels of 6%-7% ($2 billion).

Digging into the firm’s segment opportunities, much concern in the market has surrounded Campbell’s ability to leverage the synergies from its tie-up with Snyder’s-Lance last year. However, we’ve long thought that 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. The strength of its legacy portfolio is evident in the growth Pepperidge Farm has consistently chalked up, with retail sales up 2.4% compounded annually since fiscal 2015, including 18 quarters of consecutive gains, while Goldfish has boasted a 3.9% 3-year compound annual sales growth. Following the deal, the combined business now includes nine power brands in snacking (which make up 70% of the segment’s sales and stand to account for 90% of the growth going forward). And while management believes the brands in the Snyder’s-Lance portfolio are strong (with Lance recording 5% 3-year CAGR), it stressed the opportunity to flex added marketing muscle behind this mix, targeting a 30% increase in advertising and consumer spend in this arm of its snacking business in fiscal 2020. However, Campbell also emphasized the capabilities that Snyder’s-Lance brings to the table, including its superior in-store execution, distribution and logistics know-how, and sensory innovation and manufacturing insights (which it leveraged to launch Goldfish Epic Crunch more recently). Ultimately, we believe the combination of these two operations stands to drive more than 2% annual segment sales growth longer term.

But beyond the growth prospects that characterize its snacking arm, its core soup business (just more than 50% of consolidated sales) is quite mature. However, management failed to suggest that this warrants throwing in the towel. Rather, the company attributed its lagging performance over the past decade (losing ground in sales each year between fiscal 2010 and fiscal 2018 but one) to the prior executive group opting to manage this business for cash (looking to bolster profits with no sustained commitment to funnel investments into the aisle). In this vein, between fiscal 2014 and fiscal 2018, within the meals and beverage segment spending was down 20%, sales slumped 6%, soup share eroded 3 points, while EBIT held flat. This not only opened the door to heightened competition but also impaired its retail relationships. However, just more than 10 years ago, Campbell was able to string together three years of sales gains in its soup business because of the focus and resources management expended on the business over a multi-year horizon, which propped up soup sales between fiscal 2005-07 (growing nearly 5% compounded annually over that period). While management was quick to suggest that it doesn’t view this level of growth as realistic, it believes that by fueling additional spend in the category the path to stability is tangible. As such, Campbell plans to direct an additional $70 million behind the business over the next three years (increasing research and development spend by 50% to grow sales of new products by mid-teens), to enhance the product, price-pack architecture, and expand the distribution of its fare, while moving away from the deep discounting that it has resorted to in the past. As such, we haven’t wavered on our segment outlook, which calls for the meals and beverages to return to around 1% growth on average over the next decade.

While we surmise management will maintain an outsize focus on steadying its underlying operations over the next several years, we wouldn’t be surprised if the firm ultimately regained an appetite for acquisitions at some point down the road (once leverage levels have approached the firm’s 3 times target). However, we expect any potential tie-up will generally center on smaller, bolt-on deals that are unlikely to move the needle on its financial performance. From our vantage point, the benefits stem from adding niche businesses to its mix extend beyond enhancing its category exposure or capabilities. Rather, we believe smaller niche operators have demonstrated an ability to be more agile in adapting their mix to changing preferences. As such, we perceive tie-ups with these operators as potentially affording Campbell the opportunity to extract insights into how to respond to evolving consumer trends in a timelier fashion. We think the inability to do so has plagued firms throughout the grocery store and view efforts to grease the wheels of its innovation cycle positively.

Beyond the intended carve outs of its fresh and international fare (representing $2.1 billion in fiscal 2018 sales, about one fifth of its consolidated base), we asked CEO Clouse about the merits of slimming down further. And while he suggested that the firm is committed to executing on the task at hand, he left the door open for select asset sales down the road. Although we concur that shrinking to grow is not a sustainable plan, we view efforts to concentrate its resources to steady its business on its home turf, which has been struggling at the hand of intense competitive angst, favorably.