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Campbell's Soup On A Slow Simmer (CPB)
The market has rebounded upward sharply since mid-February. In addition to the market run-up, economic forecasts are starting to predict a slowdown in the United States in the second half of the year. Investors are starting to take a more defensive posture in allocating their portfolios. Food companies rank near the top of that list. One that has been a bit of a disappointment of the past five years has been Campbell Soup Company (NYSE: CPB). CPB has been struggling to revitalize its brands, improve profitability and divest itself of more marginal business lines.
Soup, Snacks and Sales
The U.S. soup business is the backbone of CPB's franchise. Campbell also has solid businesses in beverage, sauce and baked snack lines.
Condensed soups account for approximately 50% of U.S. soup sales and nearly 15% of the firm's total revenue, and it also generates operating margins of about 25%. Unfortunately for CPB, soup sales have been in steady decline for about 10 years. The company controls over 70% of the $4 billion domestic soup market.
Competition from branded food companies and private label brands is eating into sales and putting pressure on margins. An additional risk to the soup business is now approximately 35% of sales are generated outside the United States. This presents CPB with currency risk.
CPB's beverage, sauce and baked-snack food lines are being built up to bridge the weakness that of the faltering soup business. Prego pasta sauce and V-8 vegetable juice lines have been generating double-digit growth in recent quarters. Improvement has also been made in the Pepperidge Farm line, and Goldfish snacks have been producing solid consistent 5% to 6% revenue growth.
International sales of soups and sauces have also produced double-digit growth; however, half of the gain was the result of favorable currency exchange. The risk for international growth lies in the reversal of that same favorable currency exchange. The strength of snack foods has helped drive overall operating margins back up over 15%. Godiva, CPB's well established chocolate candy brand, has shown sales improvement; however, the operating margins of this business lag behind the far more profitable soup business.
Future Financial Performance
The question for investors to answer is, is there room for further improvement in CPB's revenue and operating margins? Current Wall Street estimates are for sales in the third quarter to be $1.79 billion and 40 cents per share. There are additional headwinds facing the soup business. General Mills' (NYSE: GIS) Progresso has launched some new microwave-ready soups that may cut into Campbell's commanding market share lead. Excluding foreign currency effects (which could be significant) future revenue growth will only advance at a 4% annual rate, that is inclusive of approximately 1% from acquisitions. Operating margins are expected to increase to 17%, a small improvement; however, rising raw materials and energy costs may be a strain on that number.
Capex will be approximately $330 million this year. As capex has stabilized, free cash flow may now be directed to improving shareholder returns. The balance sheet of CPB is quite leveraged with debt exceeding 60% of total capitalization. Reducing debt will give CPB more flexibility and help ramp-up earnings by reducing overall interest costs. Share buybacks and increasing the dividend are two other options for the company. The increase of the dividend may be the preferred option for the company. The dividend was cut 30% in 2001. The main influence for ramping-up the dividend may be the 40% ownership of the Dorrance family. They were supportive of the cut as it was quite necessary to turn the operations around. The family and its foundation hold five of the 16 seats for the company's board of directors.
Future Outlook
Campbell has also been mentioned frequently as a possible acquisition target. The current level of debt and the near-majority ownership of the family will make that reality fairly difficult to achieve. The real issue may be the debt and not the family. With 60% debt, there is little flexibility in structuring a buyout.
Given a substantial premium to its current price, it might be reasonable to see the family approve a buyout. The lagging dividend and stock price over the past few years might prove to be incentive for family members to re-liquefy their asset base through a buyout at a substantial premium. The company was given substantial time to turn operations around and now it is time to produce. If the lagging results continue, CPB may be forced to pursue other options. Next week's earnings report will give one of the first glimpses into that future.
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Soup, Snacks and Sales
The U.S. soup business is the backbone of CPB's franchise. Campbell also has solid businesses in beverage, sauce and baked snack lines.
Condensed soups account for approximately 50% of U.S. soup sales and nearly 15% of the firm's total revenue, and it also generates operating margins of about 25%. Unfortunately for CPB, soup sales have been in steady decline for about 10 years. The company controls over 70% of the $4 billion domestic soup market.
Competition from branded food companies and private label brands is eating into sales and putting pressure on margins. An additional risk to the soup business is now approximately 35% of sales are generated outside the United States. This presents CPB with currency risk.
CPB's beverage, sauce and baked-snack food lines are being built up to bridge the weakness that of the faltering soup business. Prego pasta sauce and V-8 vegetable juice lines have been generating double-digit growth in recent quarters. Improvement has also been made in the Pepperidge Farm line, and Goldfish snacks have been producing solid consistent 5% to 6% revenue growth.
Future Financial Performance
The question for investors to answer is, is there room for further improvement in CPB's revenue and operating margins? Current Wall Street estimates are for sales in the third quarter to be $1.79 billion and 40 cents per share. There are additional headwinds facing the soup business. General Mills' (NYSE: GIS) Progresso has launched some new microwave-ready soups that may cut into Campbell's commanding market share lead. Excluding foreign currency effects (which could be significant) future revenue growth will only advance at a 4% annual rate, that is inclusive of approximately 1% from acquisitions. Operating margins are expected to increase to 17%, a small improvement; however, rising raw materials and energy costs may be a strain on that number.
Capex will be approximately $330 million this year. As capex has stabilized, free cash flow may now be directed to improving shareholder returns. The balance sheet of CPB is quite leveraged with debt exceeding 60% of total capitalization. Reducing debt will give CPB more flexibility and help ramp-up earnings by reducing overall interest costs. Share buybacks and increasing the dividend are two other options for the company. The increase of the dividend may be the preferred option for the company. The dividend was cut 30% in 2001. The main influence for ramping-up the dividend may be the 40% ownership of the Dorrance family. They were supportive of the cut as it was quite necessary to turn the operations around. The family and its foundation hold five of the 16 seats for the company's board of directors.
Future Outlook
Campbell has also been mentioned frequently as a possible acquisition target. The current level of debt and the near-majority ownership of the family will make that reality fairly difficult to achieve. The real issue may be the debt and not the family. With 60% debt, there is little flexibility in structuring a buyout.
Given a substantial premium to its current price, it might be reasonable to see the family approve a buyout. The lagging dividend and stock price over the past few years might prove to be incentive for family members to re-liquefy their asset base through a buyout at a substantial premium. The company was given substantial time to turn operations around and now it is time to produce. If the lagging results continue, CPB may be forced to pursue other options. Next week's earnings report will give one of the first glimpses into that future.
Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!
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