Campbell Soup Shows That Shoppers More Price-Sensitive Than Investors

By Stephen D. Simpson, CFA | May 21, 2013 AAA

This has been a banner year for investors in consumer product companies, particularly staples like packaged foods and beverages. What makes that interesting is that the backdrop hasn't been quite that strong – organic revenue growth has been hard to come by and margin leverage is not exactly plentiful. And yet, despite worries about sustainable growth in the soups business and the weakness in the beverage business, Campbell Soup (NYSE:CPB) has seen its stock outperform the likes of Nestle (OTC:NSRGY), Kellogg (NYSE:K), General Mills (NYSE:GIS), and Coca-Cola (NYSE:KO).

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Good Top-Line Performance In The Fiscal Third Quarter
Campbell Soup certainly helped its case with a revenue beat in the fiscal third quarter. Revenue rose 15% for the quarter, ahead of the 12% growth called for by averaging the sell-side analyst revenue targets. Organic growth was a more sedate 4%, but still better than expected.

Sales performance was led by the soups business, a segment that has been surprisingly volatile for a while now. Overall “Simple Meals” revenue was up 11% on an 11% improvement in volume, with soups up 14% on double-digit volume improvement. U.S. beverage revenue fell 5% on a slight volume decline, while global baking/snacking rose 5% (on 5% volume growth) and international simple meals revenue rose 2% on a 4% volume gain.

Turning to margins, gross margin declined over two points and missed the analysts' target by 80bp. Management was strong with its expense containment, though, and operating income rose 9% and delivered an on-target operating margin of 14%. While there are certainly some questions remaining about this business, this was on balance a pretty solid result.

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Can Management Sustain The Growth?
The biggest concern I have with Campbell in light of this quarter's performance is whether or not it's sustainable, as results have been quite volatile in recent quarters due to buy-ins ahead of price changes, alterations to the marketing/promotion strategy, and new product introductions, to say nothing of the behavior of competitors and rivals.

In the soup business, for instance, it would seem that unseasonably cold weather boosted the business. There's not much evidence that Campbell has gained meaningful share from General Mills (NYSE:GIS), and the recent Nielsen data hasn't shown all that much reason to be excited about the uptake of new products.

Looking at the baking/snacking side, I have to wonder whether the company has benefited from the Hostess bankruptcy and the fact that those products have been unavailable for some time. Maybe the company is out-executing Mondelez (Nasdaq:MDLZ) and Kellogg, but I suppose we'll know more when Flowers (NYSE:FLO) gets the Hostess brands back in the supermarkets.

Last and not least, the beverages business continues to struggle, as the core V-8 franchise languishes. This has been a problem for several quarters now, and while I didn't expect an immediate turnaround, I think investors would like to hear more specificity from management as to how they intend to turn around the business. Perhaps Campbell Soup lacks the scale to really revise this franchise, and maybe the V-8 brand would do better in the hands of a company like PepsiCo (NYSE:PEP), Coca-Cola, or (much less likely) an emerging market company like Tingyi that wants to expand into developed markets.

The Bottom Line
Although Campbell Soup reports more quarter-to-quarter volatility than you'd probably expect and the balance sheet is weighed down with a lot of debt, it's hard to quibble too much with a company that generates strong returns on capital, converts revenue to free cash flow at a relatively good rate, owns valued brands, and has a good dividend record. So, if the consumer staples sector is going to run this far, why shouldn't Campbell Soup go along?

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All of that said, I don't see a lot of absolute value left in these shares. I'm looking for long-term free cash flow growth in the neighborhood of 4% to 5%, and the resulting fair value suggests that the stock is overpriced by 10% to 15% today. A few years of below-market returns may not bother a long-term Campbell Soup shareholder, but I think it will be a while before the financials catch up with the valuation such that it's a bargain again.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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