5%-Yielding Conagra Remains A Deep-Value Play (NYSE:CAG)

Introduction

It’s time to talk about one of the victims of elevated inflation. That company is Conagra Brands, Inc. (NYSE:CAG), a packaged foods giant I started to like a lot last year.

My most recent article on this stock was written on November 20, when I went with the title “Why Conagra Is A Top-Tier Value Play For 2024 And Beyond.”

Since then, shares have returned 1.3%, which is underwhelming compared to the S&P 500’s 12.7% return.

However, it’s a start, as the stock is finally not going down anymore.

Because of the inflation surge that resulted from massive fiscal and monetary stimulus in 2020 and 2021, the company struggled with limited pricing power and poor consumer sentiment.

As I often have made the case, Conagra does not have the kind of pricing power that companies like PepsiCo, Inc. (PEP) and The Coca-Cola Company (KO) have.

Hence, in my November article, I included a very ugly chart that showed that despite 6.3% pricing gains(!), the company was unable to offset a 6.6% decline in volumes.

In this article, I’ll update my bull case, as Conagra is making progress – despite headwinds.

As its stock price suggests, we are still in the early innings of its recovery.

However, if it works out, I believe the stock could generate elevated returns on a prolonged basis.

So, let’s dive into the details!

Conagra Is Growing In The Areas That Matter Most

Last month, the company presented at the 2024 Consumer Analyst Group of New York, also known as CAGNY.

One of the most interesting things about Conagra is its transformation.

This is what I wrote in July of last year (emphasis added):

The purpose is to turn the company is a modern food company with top-tier products that provide both stronger demand, higher margins, and (related) better pricing power.

Especially in the current market environment of high inflation and consumer weakness, we see that the strongest consumer companies are the ones with strong brands and pricing power.

During the CAGNY, the company elaborated on this as well, as it said that it transformed major segments that include frozen products, snacks, and staples. This also includes spin-offs like Lamb Weston Holdings, Inc. (LW), which produces a wide range of fries.

Currently, roughly 80% of its products are ranked number one or number two in the categories they serve!

It now is the fourth-largest food company in America. Only PepsiCo, The Kraft Heinz Company (KHC), and General Mills, Inc. (GIS) are larger.

Having said that, while its stock price may not reflect it, the company has delivered consistent earnings growth, with an impressive earnings CAGR of 11% since its 2016 fiscal year.

Even during the challenging period of FY2019-FY2023, the company performed surprisingly well, as the business compounded its adjusted EPS by roughly 8% per year.

Looking at the chart below, this beats its peers by a wide margin.

Going back to my market-leading comments, as we can see below, after the pandemic, the company has expanded its market share in key sectors like frozen foods.

Although I am not a fan of processed foods (I try to cook everything from scratch), I like this market, as convenience is key for so many people. Offering the right products goes a long way in this industry.

As a result, over the past four years, the company has seen rapid growth in single-serve meals and multi-serve meals, with veggies behind with 2.7% compounding sales growth. Both single-service and multi-serve categories saw annual compounding growth exceeding 6.0%.

As a result, Conagra has turned into the largest frozen food company in the world!

On top of that, let me share the chart below with you as well. As we can see, the company’s “innovation program” has clearly yielded higher market shares after the post-Great Financial Crisis years were disappointing – especially because it ended a multi-decade market share expansion.

Now, the company is back on track.

It now has a 45% market share in the single-serve meal segment, beating its biggest peers by a wide margin when it comes to expanding its footprint in this area.

This frozen single-serve segment also withstood inflation pressure, growing by 33% since 2020.

With all of this in mind, let’s take a closer look at recent results.

Is Conagra Bottoming?

During the second quarter of its 2024 fiscal year, the company saw net sales of $3.2 billion. That’s a decline of 3.4% on an organic basis (adjusted for M&A and foreign exchange rates).

Total sales were down 3.2%.

As we can see below, the volume decline contributed to most of this, as volumes were 2.9% lower on a year-over-year basis.

Not even pricing could save the day.

During its call, the company noted that while it continued to suffer from consumer weakness in its quarter, it is seeing some green shoots.

At a macro level, the industry-wide shift in U.S. consumer behavior that we discussed on last quarter’s call persisted into the second quarter. These behavior shifts continued to pressure volume and mix. However, while the consumer is still deploying some value-seeking tactics when they shop, we are seeing clear progress when it comes to volume recovery. – CAG 2Q24 Earnings Call

In general, it’s not all bad.

Despite challenges, the company saw progress in certain areas.

For example, the international segment saw organic net sales growth of 5.6%, driven by a strong performance in key markets such as Mexico and Canada.

According to the company, tailwinds came from improved brand activation, point-of-sale performance, innovation (like new and improved products), and improved distribution capabilities.

On a side note, I will likely write an article on stocks in the food distribution industry and how to capitalize on important trends in the not-so-distant future.

In the food service segment, organic net sales grew by 4.3%. This was mainly due to favorable price/mix and better distribution in the Frozen portfolio.

Unfortunately, the snack and frozen foods did not perform well, mainly due to elevated inflation and the impact this had on consumers.

However, the company made strategic investments to drive growth, including targeted investments in brand-building initiatives.

The main focus here was on frozen foods, which we discussed in the first part of this article.

It also needs to be said that the company did a tremendous job growing free cash flow and lowering debt.

This is very important for shareholders and will allow the company to boost dividends down the road.

Looking at the data below, we see that free cash flow in the first half of FY2024 was roughly 6x higher compared to the prior-year result.

Meanwhile, the repayment of $500 million worth of debt over the past 12 months lowered the net leverage ratio to 3.55x.

With regard to its dividend, CAG currently pays $0.35 per share per quarter. This translates to a yield of 5.0%.

This dividend is protected by a 54% 2024E payout ratio and a much healthier balance sheet, which comes with an investment-grade credit rating of BBB-.

Its most recent dividend hike was 6.1% on July 27, 2023. The five-year dividend CAGR is 10.1%, which is very high for a company with a yield of 5.0%.

On a side note, please be aware that CAG is not a dividend cutter. The chart below shows two major declines. These were spin-offs, like the one where the company parted ways with Lamb Weston.

So, what about the valuation?

Guidance & Valuation

As we can see below, the company adjusted expectations going into the remaining two quarters of its 2024 fiscal year.

It now expects a full-year decline in organic sales.

We’re updating our guidance for fiscal ’24, reflecting both the consumer environment and the additional brand investments in the second half of the year. Our new guidance includes organic net sales decrease between 1% and 2% compared to fiscal ’23, adjusted operating margin of approximately 15.6%, and adjusted EPS between $2.60 and $2.65. – CAG 2Q24 Earnings Call.

Moreover, as we saw in the quote above, the company expects lower operating margins and lower adjusted EPS of $2.60 to $2.65.

As mentioned, we are updating our guidance for fiscal ’24 to reflect our year-to-date results, expectations for the slower pace of volume recovery, and the additional brand investments in the second half. – CAG 2Q24 Earnings Call.

With that in mind, analysts agree with the company, as they expect $2.60 in EPS this year.

The good news is that analysts expect investments in growth to pay off, with 4% growth in 2025 and 7% growth in 2027.

Moreover, CAG is currently trading at a blended P/E ratio of just 10.7x, which is well below the long-term normalized ratio of 13.5x.

While I believe a recovery will take time, as I do not expect the fight against inflation will be won soon, I really like the valuation of CAG and expect a gradual return to $39 per share in the years ahead.

This translates to an undervaluation of roughly 40%.

On top of that, it has a well-protected 5.0% dividend that is in a great spot to enjoy decent mid-single-digit annual growth.

For investors looking for undervalued high-yield investors, I believe CAG may be the right play.

Takeaway

Conagra faces headwinds from inflation and shifting consumer behavior, which have negatively impacted its recent financial numbers.

However, its strategic transformations and brand investments show promising developments for future growth.

Meanwhile, with strong free cash flow, debt reduction, and a solid dividend, CAG presents an undervalued opportunity for investors seeking dividend income and potential capital gains.

Although near-term challenges seem to be very persistent, the company’s long-term outlook remains favorable, making it a terrific deep-value high-yield play in the defensive consumer space.

Pros & Cons

Pros:

• A Long-Term Transformation: Conagra is undergoing a strategic transformation, which is focused on streamlining its product portfolio and improving volumes and earnings growth.
• Market Leadership: With a significant market share in key segments like frozen foods, CAG is positioned as a leader in the industry.
• Financial Health: Despite some headwinds, the company’s strong free cash flow generation and debt reduction efforts bode well for shareholder returns in the future.
• Dividend Stability: CAG offers a well-protected dividend, which currently yields 5%.

Cons:

• Inflation Impact: Elevated inflation and consumer weakness have resulted in very poor volumes.
• Guidance Revision: As a result of poor consumer sentiment, CAG’s revised guidance for 2024 indicates lower expectations for sales and earnings.
• Competitive Landscape: While CAG holds a strong market position, competition from peers is an always-present risk.