It's been easy to criticize ConAgra (NYSE:CAG) management over the years, as relatively ham-fisted management of junior varsity brands has led to pretty pathetic growth and margin performance relative to its peers. What's true about the past is not automatically true about the future, though, and I think ConAgra is in perhaps the best shape it has been in the time I've watched the company. There's still a lot of work to be done in improving margins and cash generation, but in an overvalued sector ConAgra looks like an interesting relative value.

Decent Results To Close The Fiscal Year
ConAgra reported 35% overall revenue growth, a figure that was very clearly heavily influenced by the acquisition of Ralcorp. Absent the nearly the $1 billion in acquired revenue, sales would have been up about 6% - which is still pretty good for this sector of late. 

SEE: Key Players In Mergers And Acquisitions

Consumer sales were up a reported 7%, or 2% on an organic basis as volume increased 3% and price/mix took 1% of sales growth away. Commercial was up 5% as reported for the quarter, and Ralcorp operations brought in $962 million of revenue – a number that's hard to reconcile with the year-ago figure for the March 2012 quarter of $1,062 million because of the non-overlapping calendar.

Margins were a mixed bag. It's not unusual at all for the integration of a major acquisition to be disruptive, but it sounds like ConAgra management is seeing solid synergy realizations from the deal. Even so, gross margin was basically flat and operating margin declined 30 basis points (operating income was up a reported 31%), and these were a little soft relative to expectation.

FY2014 Should Be A Good Year For Margins
Fiscal 2014 is shaping up as an important year for ConAgra's management. If this management team wants to build/maintain creditability that this is a new era for ConAgra, they're going to have to deliver some of the margin leverage that lies at the center of almost every bullish thesis on ConAgra.

First off, agricultural input cost inflation should be much milder over the next twelve months than it has been recently. Not unlike General Mills (NYSE:GIS), Kraft (Nasdaq:KRFT), and Nestle (Nasdaq:NSRGY), ConAgra found that significant price increases led to significant volume decreases and operational deleverage throughout the system. Consequently, there were impacts to both sales and margins as the company absorbed what were in many cases double-digit cost increases.

Second, the Ralcorp integration should continue to generate operating cost savings and better margins. So far management has done well with an “under-promise/over-deliver” approach, but expectations are almost certainly going to increase after this quarter.
 
Balancing The Businesses Will Be Tricky
One of the challenges ConAgra management will face is managing a large branded food business simultaneously with a large private label business. With the Ralcorp deal, about 25% of the company's revenue will be from private label (and I'd be tempted to include the Commercial business with that), and that's a business that has seen its own bout of pricing pressure lately.
 
On the branded side, ConAgra has actually been looking better of late in terms of U.S. market share in many categories. With possible disruption in categories like peanut butter and tomatoes from Hormel's (NYSE:HRL) acquisition of Skippy and the acquisition of Heinz (NYSE:HNZ) and opportunities to gain share in dry/frozen dinners, the branded business here may be in better shape than commonly thought.
 
The Bottom Line
I've gone back and forth on ConAgra's stock, largely in response to the market's shifting sentiment towards the packaged food space. Last quarter, for instance, I thought things were getting a little too hot and I suggested stepping back – and the stock obliged with a greater-than-5% drop.
 
Now, though, I'm a little more bullish on the stock. There were still some earnings quality issues this quarter and I'm not sold on the rebound in ConAgra's branded volumes, but I think the balance favors a positive slant. I believe management can transform long-term sales growth of around 3% into more than double that rate of free cash flow growth, and I believe these shares are undervalued below $40, though I acknowledge an above-average risk profile to this stock.

Related Articles
  1. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  4. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  5. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  6. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  7. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  8. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  9. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  10. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center