ConAgra Exits Commodities Trading At The Perfect Time

By Wayne Pinsent | March 31, 2008 AAA

ConAgra Foods (NYSE:CAG) announced it is shedding its volatile commodities trading business at just the right time. The volatility of that business has led to a decreased valuation of the shares. The announcement came in conjunction with a third quarter where it blew past estimates with a 60% rise in profit. Shares rose more than 7% on the good news last Thursday, but this could be just the beginning.

By The Numbers
For its third quarter, ConAgra came in strong as net income rose 60.5% to 309.1 million (63 cents per share) from 192.6 million (38 cents per share) a year earlier. The results this quarter take into account a 1-cent loss from discontinued operations, and the results a year earlier contain a 1 cent gain. Excluding those discontinued ops, earnings per share from continued operations rose 73%.

The top line came in strong as well with the company growing revenue 20.9% to $3.5 billion from $2.9 billion, while cost of goods sold rose just over 19% and selling, general and administrative expenses grew by a little more than 10.3%. The company avoided the pitfalls of other food makers like Kraft (NYSE:KFT), who suffered from spiking input costs. As a result ConAgra improved gross margins a full point to 27.6% from 26.6% a year earlier, and net margins improved markedly to 8.76% from 6.6%. This data points to strong results from a company that is essentially unfazed by a weak economic environment. (For more on these fundamental numbers, check out Reading The Balance Sheet and Testing Balance Sheet Strength.)

Right Time for a Commodities Exit
ConAgra CEO Gary Rodkin has noted that the volatility of its commodity trading business has led to a discounting of the company's stock to account for the risks. This will no longer be a problem. ConAgra announced along with its earnings release that it will be selling its commodity trading business. Rodkin points out that the commodity trading business is cyclical and it is best to sell when times are good.

Times are great for commodity trading, and it doesn't hurt that the on the same day the Chicago Mercantile Exchange announced wider trading limits to reduce speculation in the commodities market. This measure by the CME will make it more costly to trade, which makes it a good time for ConAgra to exit. Many food companies use hedging to reduce the risk of food prices on its margins, but few have business units dedicated to the practice. This means ConAgra can still hedge its costs (hopefully as well as it has been) and still unload the division opportunistically. Many hedge funds are looking to get into the business, so ConAgra will have its pick of suitors.

This divestiture will also help ease the concerns about volatility within ConAgra's earnings. The stock sells at just 14.5 times earnings, despite its big growth compared to Heinz (NYSE:HNZ) and Kraft, which sell at 18 and 19 times respectively. I think this is a long-term positive for the company and will help bring a higher value to the shares.

The Bottom Line
ConAgra released a great quarter, in which net income rose 60%, and the company made improvements all around. The company grew a lot due to its commodity trading business, which has put a weight on the shares due to its volatility. With ConAgra shedding this unit, and the attractive prospects for the business, I think the company will receive a higher valuation in the market and is an attractive long-term investment.

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