Brands Conagra.: Positive Valuation, But With Some Risks (NYSE:CAG)

Investment Thesis

Brands Conagra (NYSE:CAG) is a holding company that deals with the production and packaging of various food products.

The company is investing heavily to strengthen its product portfolio. In fact, on August 9, Conagra Brands expanded its portfolio by acquiring Sweetwood Smoke & Co., maker of the premium FATTY Smoked Meat Sticks brand.

In addition, Conagra Brands has announced several new product launches that will be made in the summer of 2024, and this makes this company very attractive for the foreseeable future.

Conagra Brands also pays attractive dividends. It has a dividend yield of 4.51% and a double-digit dividend growth over the past 5 years of 10.49%.

After evaluating the company, I have come to the conclusion that there is value and therefore my advice is to BUY.

Latest company results overview

Looking at the most recent 10-K filed by the company on July 11, 2024, we can see that there was a slight decrease in net sales, mainly due to inflation. In fact, in fiscal 2023 net sales were $12,277.0 million while in fiscal 2024 net sales were $12,050.9 million, down 1.8%.

However, if we look in more detail at the net sales broken down by category, we can get more information and some positive considerations:

We can see that the Grocery & Snacks and Refrigerated & Frozen categories are the ones that generate the most sales for the company. Grocery & Snacks was down just 0.5% despite inflation, while Refrigerated & Frozen was down 5.6%, and given that it accounts for about 40% of net sales, it raises some concerns.

The international category registered an increase of 7.6%, and it should be taken into account that the international category also includes frozen and refrigerated products that are exported abroad. For this reason, I believe that the decline in Refrigerated & Frozen is not due to product dislike, but rather to price and strong competition in the sector. The growth of the international sales sector could allow the company to acquire new customers abroad to increase sales volume, and I think there is still a lot of room for improvement as the international sector still has little impact on total sales.

A positive factor to consider is the operating profit data by category. In fact, the Refrigerated & Frozen category, although very influential in net sales, does not generate a very high operating profit. In fact, most of the operating profit is made by the Groceries and Snacks category:

Expanding the portfolio and new products

The most important challenge faced by a company operating in the food sector is to create the best product portfolio to meet the tastes of its customers. In this regard, I find Conagra Brands very good at managing its products and brands. On August 9, 2024, the company announced the acquisition of Sweetwood Smoke & Co., which makes a protein snack called FATTY Smoked Meat Sticks.

This is an interesting product in my opinion because it is not positioned at the same level as sweet snacks, but rather falls into the category of healthy/protein snacks.

But the most interesting news is the one released on June 26, 2024, where the company states the launch of more than 50 new products in the summer of 2024. The new products will cover several categories, although the main focus will be on Refrigerated & Frozen Category. In my opinion, this is a move that could bring some education to the company’s sales, especially in categories that have seen a slowdown over the past year. If the products are successful, they could bring a nice boost to sales due to the novelty effect of the next period.

More details about the new products can be found on the company’s official website.

Dividend analysis

In this section I want to analyze the dividends offered by Conagra Brands because I consider them to be a good reason to consider buying the shares.

Looking at dividend history, we see good dividend growth. In fact, in the last 5 years, there has been an increase of 10.49% per year.

The company currently pays $0.35 per share in dividends. The most notable increase was in early 2021, when the dividend went from $0.21 per share to $0.28 per share.

In terms of dividend safety, we can see that the payout ratio is 52.43%, which is a good value even if a lower value would be better. With a payout ratio of 52%, I don’t expect future dividend growth like the past. However, it should be noted that the launch of new products could generate earnings growth, which could allow the company to increase dividends without increasing the payout ratio too much.

Financial analysis

Looking at the balance sheet data, we notice that the company has a good availability of short-term assets, but most of them are inventories, which are less liquid than receivables and cash. Regarding the inventory, it should also be mentioned that in recent years there has been an increase in its value:

This could raise some concerns as it could mean that goods are in storage for longer and therefore a slowdown in the business cycle. Although it should be borne in mind that the company itself has grown in size in recent years by acquiring new brands, so this increase in stock, in my opinion, is to be considered normal.

In terms of financial strength, we can see the main solvency ratios below:

Long-term credit ratings are good, while short-term and very short-term credit ratings are a bit too low. The current ratio is less than one, which means that current liabilities are greater than current assets, even if only slightly. The quick ratio, on the other hand, has a fairly low value, and this is because the firm has relatively little cash available compared to current liabilities. These values ​​can be justified by the investments that the company makes every year, both for marketing and advertising campaigns and for the management of the product portfolio. However, it should be borne in mind that the short-term solvency is not very good, and this is a risk factor.

In terms of profitability, we note that there has been a significant decline over the past year:

As we can see, already in 2023 there was a decrease compared to the previous year, so I went to investigate the reason to try to understand what costs have increased in this last period:

In the latest 10-K released by Conagra Brands, it is possible to understand the reason for the decrease in profitability, and in particular, the reasons are two: The first reason is the increase in selling, general and administrative expenses that last year increased by 13.30% , despite the slight decline in net sales. The second reason is the increase in interest expenses which increased by 5.10% compared to the previous year.

For this reason, in my opinion, it will be very important to observe the following reports to see if this trend will continue, and this should also be considered a risk factor.

The reduced dividend valuation model

Since the company has been paying dividends for many years, I decided to use the low dividend model to value Conagra Brands.

First, let’s start by looking at the historical series of annual dividends paid by the company:

As you can see, the dividends over the last 5 years have experienced quite a sustained growth corresponding to a CAGR of 8.89%. In order to estimate the future growth rate, we need to take into account that the company currently has reduced profitability, as we have seen, due to the increase in the cost of debt and cost of sales. On the other hand, we have the new products and the acquisition of the new brand that could boost sales, so I think putting it all together, we could assume a future growth rate equal to half of what we’ve seen in previous years. Therefore, a 4% dividend growth rate I think is realistic for the next few years. We chose a dividend growth rate of 4% also because it is close to the sector median according to data provided by Seeking Alpha.

As a discount rate we used a WACC of 7% estimated with the capital asset pricing model, and by the model, the valuation is very positive. In fact, we get a share price of $48.53, while the market traded share price is around $31.

Risks and red flags

We have already mentioned some risk factors to consider in the financial analysis section, such as short-term solvency and declining profitability. However, in my opinion, the main risk is that the new products launched are not appreciated by consumers. It should be kept in mind that behind a launch of so many varied products, there are a lot of marketing expenses and also expenses for placing those products in grocery stores. But if the tastes do not satisfy the needs of the customers, Conagra would have a reduction in demand that would lead to very negative effects. This risk is also highlighted in the company’s latest 10-K:

If our products fail to meet changing consumer preferences or habits, or if we fail to introduce new and improved products in a timely manner, then our return on investment will be less than anticipated and our strategy to increase sales and profits through investment in purchases. , marketing and innovation will be less successful.

For this reason, I think it is important to monitor the trend of future net sales by analyzing the following reports published by the company. If sales continue to decline in the next few reports, my assessment of Conagra brands may change.

ConCluSIonS

Conagra Brands is a very dynamic company in the Food and Packaging sector, with good potential given the plan to renew the product portfolio, including through acquisitions. The company has been generating positive results for several years and is also paying good dividends which are growing at a good pace. Conagra also has some weaknesses that are offset by a positive valuation through the low dividend model.