Campbell: Buy The Dip Opportunity – Campbell Soup Company (NYSE:CPB)

Investment Thesis

The shares of Campbell Soup (CPB) plunged 8% yesterday following the fourth-quarter results that missed on both the revenue and the EPS. A somber state-of-the-industry comment from the company chief executive officer exacerbated the bearish sentiment. The fall yesterday extended the decline that started early this year. From a technical point of view, the share price convincingly broke through a critical multi-year uptrend support line in May. The stock seems to lack a clear support level now. In 2016 when there was similarly a sharp fall, it took several weeks before a recovery happened. Would we see a faster rebound this time round? The CEO has fleshed out the tough times facing the company but she also reiterated the initiatives to tackle these challenges. Given the fundamentals to be elaborated subsequently, I believe that now is a good opportunity for mid-to-long-term investors to enter a position.

Several variables are at play, including value players expanding their presence in the U.S., the growth of store brands and the explosion of e-commerce and meal delivery services disrupting the market. We expect conditions to remain hypercompetitive for the foreseeable future.

– Denise Morrison, president and CEO, Campbell Soup (Q4 2017 Results – Earnings Call)

The Bad

Let’s first go through the negatives. Revenue has continued to fall in the latest reported quarter (Q4 2017) by 1.8% year-on-year. Organic sales declined 1% for the quarter as well as for the full year. What’s worrying is that for the largest segment – Americas Simple Meals and Beverages, the net sales organic growth rate fell 3%, attributed largely to the weaknesses in soup and V8 beverages. For 2018, the management has guided for the revenue to come in at -2% to flat, indicating that the sales pressure is expected to remain unabated. The EBIT is forecasted to perform a tad better next year with -1% to 1% growth.

The EV-to-EBITDA ratio has fallen from around 19 early in the year to 14.76. The current P/E at 29x is not excessive considering that Mondelez International (MDLZ) trades at a P/E of 36x.

ChartCPB EV to EBITDA (TTM) data by YCharts

A key solvency ratio that I found useful to track is the defensive interval ratio. Generally, a decline is not desired as it indicates a reduction in the buffer of liquid assets, an increase in its immediate payment liabilities or a combination of both. In the case of Campbell Soup, the decline in the ratio is largely attributed to the drop in receivables which is not so worrying given that the receivables turnover has been inching up. The lower receivables but higher turnover days is likely the result of retailers lowering their inventory levels, a phenomenon mentioned a number of times in the earnings call. This is bad on the short-term as destocking down the chain means that Campbell Soup’s sales suffer, which is indeed the case. However, it would not be an issue as long as the products continue to sell and the retailers replenish the goods eventually. This is evident by the climbing inventory turnover days since late 2015.

ChartCPB Defensive Interval Ratio (TTM) data by YCharts

The Good

There are actually a number of positives which you would not expect given the share price plunge. In the fourth quarter, productivity improvements of 1.8% more than offset the negative effect (1.8%) of inflation. Despite the doom and gloom headlines, particularly on the pressure from the retailers, a better pricing strategy helped to eke out another 0.1% of gains on the gross margin. The operating margin improved largely due to a 12% reduction in the marketing and selling expenses and a 5% fall in administrative expenses. For 2018, the management has guided for a “modest improvement” in the gross margin. The pessimists might lock in on the “modest” while the optimists would emphasize the “improvement”.

ChartCPB Operating Margin (TTM) data by YCharts

In terms of free cash flow, on a trailing-twelve-month basis, it is trending down. However, it is not too much of a concern as it remains near the record level achieved last year. Anthony DiSilvestro, senior vice president and chief financial officer, attributed the decline to last year’s working capital reduction, lower cash earnings and lower receipts on hedging activities. The still solid free cash flow helped the company to reduce its long-term debt further which clearly is positive.

ChartCPB Free Cash Flow (TTM) data by YCharts

With the solid free cash flow, the management has been rewarding shareholders through share repurchases as well as increasing the dividends. The last revision brought the quarterly dividend up to $0.35 per share. The dividend yield has now climbed to 3%, thanks to the sharp decline in the share price.

ChartCPB Dividend Yield (TTM) data by YCharts

Strategic Growth Initiatives

The management team does not comprise ostriches with their heads in the sand. In the earnings call, Morrison reiterated the four key strategic imperatives outlined in July.

Firstly, Campbell Soup will continue its investment into the newly created e-commerce business unit and scale it up across North America in the areas of content creation, data analytics and the forging of new partnerships. This is to ensure that the company capture more than its “fair share of the rapidly growing market for online grocery”, which the management expects to reach $66 billion annually by 2021.

Secondly, Campbell Soup will expand its snacking and mini-meal offerings, going beyond cookies and baked snacks, to ride on the market growing at around 3%. The management believes that consumers have not abandoned snacking altogether but are seeking “new and better-for-you snacking options”.

Thirdly, the company will make good on its pledge to cater to the rising “real food” movement. This includes “adding more vegetables and whole grains; converting all our soups to chicken with no antibiotics, while continuing to eliminate artificial colors and flavors from our products and completing the removal of BPA from the lining of our cans in the U.S. and Canada.”

Finally, the company recognizes the healthy eating trend and intend to invest along the theme of natural, organic, functional and fresh. In addition, it will continue to fund its personalized nutrition start-up, Habit. The management expects the start-up to eventually come up with multiple business models that “ultimately will create value”.

Conclusion

It is undeniable that the revenue is on a downtrend. Nevertheless, the free cash flow continues to be strong, aided by ongoing productivity improvements helping to reduce costs. The net debt level has fallen to a five-year low. The management is cognizant of the challenges and has in place several strategic imperatives to position the company to capture the shifting market. With the share price falling to a two-year low and having declined 28% from the 52-week high, the buying opportunity is emerging for mid-to-long-term investors. A 3% dividend yield would also attract those seeking income. In the short-term, do note that the sentiment remains weak.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CPB over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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