Tickers in this Article: CAG, GIS, RAH, SJM
As investors have seen with General Mills (NYSE:GIS) a couple of days ago and now again with ConAgra (NYSE:CAG), the packaged food industry is still facing pretty challenging conditions. In particular, it looks as though companies can raise prices if they want, but they see an almost immediate hit to volumes. At the same time, give credit where it's due - ConAgra has continued to make progress with its margins. With Ralcorp (NYSE:RAH) now coming into the fold, the next year or two could be pretty interesting for ConAgra, even as the retail environment remains challenging.

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Tough Sales, but Good Margins in Fiscal Second Quarter
ConAgra maintained its year-and-a-half-long streak of non-negative consumer performance this quarter, but only just barely. Just as impressive, though, was the company's ongoing margin improvement.

Revenue rose 9% this quarter, with 11% reported growth in the consumer segment. All of the growth came from acquisitions, though, as the company saw a 4% improvement in price and mix offset by a 4% decline in volume. The commercial business saw a 5% revenue improvement this quarter.

ConAgra did well on its margins. Gross margin (adjusted) improved about a half-point as the company saw lower input costs. Operating income rose 9%, and while ConAgra didn't keep all of that gross margin leverage (only about half of it made it to the operating line), that was also despite spending more money on brand-building. It's also worth noting that the consumer business saw a 12% segment income growth, while corporate expenses fell about 13%.

SEE: How To Decode A Company's Earnings Reports

Elasticity Still a Problem
One of the big challenges for packaged goods companies right now is that consumers just aren't willing (or able) to absorb much in the way of price inflation. So when companies boost their prices, they pay for it in terms of volume.

For now, it looks like ConAgra may be having the hardest time with this phenomenon. Volume and price pretty much canceled each other out this quarter. In comparison, General Mills was able to boost prices a bit and still keep volume flat. Smucker (NYSE:SJM), too, was able to get about a 2% boost out of its price/volume trade-off, while Heinz (NYSE:HNZ) and Kellogg (NYSE:K) both managed around a 3% growth when they last reported.

I have to ask if some of the trouble here still revolves around ConAgra's relatively weak brand positioning. Said differently, the company just doesn't offer many category-leaders where customers will continue to buy even with higher prices.

SEE: The Power Of Branding

A Bigger Platform to Work on Margins
I liked the Ralcorp deal when it was announced in November, and I still think this is a good deal for ConAgra, even if it strains the balance sheet more than a little bit. ConAgra has been making good progress with its operating efficiency, and I think the inclusion of Ralcorp will offer up some good opportunities to strip out costs in the near-term and improve asset utilization/turnover in the long-term.

It's worth noting, too, that management signaled that they're not done thinking about deals. Digesting the Ralcorp deal will take time (and they need to pay down some of the debt), but expect ConAgra to keep looking for private label tuck-in deals.

The Bottom Line
At the risk of being too optimistic about the long-term potential of the Ralcorp deal, I like the direction ConAgra is heading. Its lack of brand leverage in the consumer business isn't great, but this is increasingly going to be a story about operating efficiency.

This stock is already up about 25% from its late summer lows, and the reported EV/EBTIDA multiple doesn't really scream "bargain" at roughly 11 times. That said, the cash flow growth story here is looking more interesting, and I think ConAgra is no worse than a solid hold today.

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

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