One of the things that always seems to be a little bit ironic to me about the markets is the way that fear tends to weave a web of intrigue and uncertainty under just about all conditions. That often means that when the market starts to correct, investors, analysts and economists don’t just look for the reasons behind the correction, but also start to fret about how bad things are really going to get. It also means that when things are going well, those same groups wring their hands about how long it will last and when the tide will turn.
Over the last month or so, as economy has started to pick up, I’ve seen an increasing amount of commentary among analysts and economists about the pace of inflation, and whether the pent-up demand from long restrictions on social gatherings and activities was going to lead the economy to heat up much faster than economists and the Federal Reserve had anticipated. That raises the question of whether the Fed might be forced to start raising interest rates earlier than it had previously planned. Early indications from Chairman Powell and other members of the Fed Board of Governors don’t seem to point in that direction – in fact, for the most part, they still say that even as certain economic indicators are showing larger increases than many predicted, the broad economy is still generally operating within the ranges it believes it needs to justify the moderated, accommodative approach the Fed has continued to take throughout the pandemic and into this year.
One of the areas that seems to seeing a strong reaction to indications of faster-than-anticipated inflation is in the Food Products industry – an industry that I usually like to think of as a good way to position a portfolio with moderated, even defensive options to help moderate risk. One specific area that seems to be showing unexpected inflationary conditions is in the cost of goods companies in this industry have been seeing over the last few months, and which many fear could continue into this year. Conagra Brands, Inc. (CAG) is an example. After the company’s latest earnings report, management revised its outlook for 2022, citing cost increases that could extend into the next year. That news prompted investors to start dumping shares and putting pressure on the entire industry. From a peak at around $39 in early June, the stock has dropped almost -13%, sitting right now at around $34 per share. The drop includes an overnight gap from about $36 to a low at around $33.50 on the day of the last earnings announcement. The real question, of course is whether the market is simply overreacting to the revised guidance (always a possibility) or if risk is truly increasing. Does the company have the fundamental strength to manage inflationary risks, and if it does, does the stock’s drop really just mean that it offers an attractive value right now? Let’s find out.
Fundamental and Value Profile
Conagra Brands, Inc., formerly ConAgra Foods, Inc., operates as a packaged food company. The Company operates through two segments: Consumer Foods and Commercial Foods. The Company sells branded and customized food products, as well as commercially branded foods. It also supplies vegetable, spice and grain products to a range of restaurants, foodservice operators and commercial customers. Conagra Foodservice offers products to restaurants, retailers, commercial customers and other foodservice suppliers. The Company also operates in the countries outside the United States, such as Canada and Mexico. The Company’s brands include Marie Callender’s, Healthy Choice, Slim Jim, Hebrew National, Orville Redenbacher’s, Peter Pan, Reddi-wip, PAM, Snack Pack, Banquet, Chef Boyardee, Egg Beaters, Rosarita, Fleischmann’s and Hunt’s. The Company sells its products in grocery, convenience, mass merchandise and club stores. CAG’s current market cap is $16.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined about -28%, while Revenues dropped by -16.68%. Earnings and sales also dropped in the last quarter – by -8.47% and -1.14%, respectively – but that doesn’t paint a complete picture of the company’s profitability, which has remained very stable. The company’s margin profile over the last twelve months is healthy, with Net Income at 11.61% of Revenues over the past twelve months tapering only slightly to 10.27% in the last quarter.
Free Cash Flow: CAG’s free cash flow is healthy, and strengthening at about $1.51 billion. That marks a steady increase from $1.4 billion in mid-2020, and $575.6 million at the beginning of 2019. The current number also translates to a useful Free Cash Flow Yield of about 8.44%.
Debt to Equity: CAG has a debt/equity ratio of .96. That number has declined steadily from 1.58 at the beginning of 2019, but the number remains a tad high, a reflection of the reality that the company’s liquidity remains a question mark. In the last quarter Cash and liquid assets were a little over $79 million – a decline from $438.2 million in the last quarter of 2020, versus about $8.3 billion in long-term debt. Most of that debt is attributable to CAG’s acquisition of Pinnacle Foods in the last quarter of 2018. The complexities associated with the transition of the two companies into one is part of the reason the stock struggled into the early part of 2019, but recent reports indicate that the synergies the company has worked to achieve have been working. In the last year and a half, long-term debt declined by more than $2 billion, which is a positive.
Dividend: CAG pays an annual dividend of $1.25 per share – which the company increased from $.85 in its last earnings call of 2020, and $1.10 earlier this year, and which translates to an annual yield of about 3.69% at the stock’s current price. An increasing dividend is a strong sign of management’s confidence in their business model and the operating success in the future.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at about $45.50 per share. That means the stock is very nicely undervalued, with about 33% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above marks the stock’s price activity over the last year. The red diagonal line marks the stock’s drop from a peak in August 2020 at around $39.50 to a low in January at around $32.50. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock was approaching that peak in early July before bearish momentum pushed the stock strongly downward, to around $35 late in the month. After temporarily recovering prior to this month’s earnings report,, the stock picked up bearish momentum again, dropping overnight from about $36 to a new low point at around $33.50. The stock has used that level as support in the past couple of days, with immediate resistance expected to lie at around $35 based on the 38.2% retracement line. A drop below $33.50 should have limited downside, with the stock’s 52-week low at around $32.50 expected to provide next support. A push above $35 could have short-term upside to about $37 where the 61.8% retracement should provide next resistance.
Near-term Keys: From a fundamental standpoint, CAG’s profile is very attractive, and its value proposition is very useful right now. The stock’s current bearish momentum has pushed the stock low enough, however that looking for a short-term bearish trade doesn’t really offer a lot of downside, so shorting the stock or buying put options is a very low-probability trade right now. A better set up would come from a push above $35 per share; that could provide a decent signal to think about buying the stock or working with call options using $37 as a near-term profit target.