HSY - Campbell Soup: Decent Prospects But Risks Remain

2023-07-16 21:44:23 ET

Summary

• Campbell Soup's recent growth has been driven by price hikes, which are not sustainable, and signs of weakness are beginning to show.
• Premiumization and efforts to attract younger consumers could support Meals & Beverages segment but execution risks remain.
• Good prospects for Campbell's Snacks business, the company's growth engine, but competitive risks are significant.

Campbell Soup’s ( CPB ) recent growth has largely been driven by price hikes which are not sustainable. Longer term, Campbell’s snacks business could support growth but competitive and execution risks are significant.

Receding pricing tailwinds, increasing promotional activity suggest soft near term prospects

Campbell Soup’s growth over the past several quarters has largely been driven by price hikes but this is not sustainable and signs of weakness are already beginning to show; inflation is moderating and consumers, increasingly stretched, are showing signs of trading down (towards private label products for instance). Campbell Soup’s growth has shown a consistent deceleration in both reported and organic terms for the nine months of the current fiscal year (which ends in July 2023) so far. For Q1 2023, Q2 2023, and Q3 2023, Campbell Soup revenues rose 15%,12.5%, and 4.7% respectively on a reported basis, and 15% , 12% , and 4% respectively on an organic basis. At this stage, there is little reason to see a change in momentum. Consumer budgets remained constrained with interest rates at relatively elevated levels (and expected to rise further by the end of this year), and competitor pressures are heating up with Campbell Soup management noting increasing promotional activity.

Premiumization efforts could support Meals & Beverages, Snacks to remain as growth driver

Looking further ahead, Meals & Beverages, the company’s biggest segment (accounting for more than 50% of revenues and more than 60% profits), could benefit from premiumization and innovation efforts which are clearly aimed at capturing younger consumers. Pacific Foods, the company’s organic soup and broths brand, continues to stay fresh with new launches (most recently Pacific Foods launched a line of hearty ready-to-eat soups, and plant-based chilis) which may help them gain market share. Company management has made clear that Pacific Foods continues to gain share among millennials, and with an 8% household penetration rate (representing a tiny fraction of the 46% millennials households in the U.S.), Pacific Foods may benefit as organic food demand continues to grow, particularly among health-conscious millennials in the U.S.

Meanwhile, Campbell’s flagship brand Campbell’s soup continues to innovate as well. The launch of new chunky soup flavors could gain favor with younger consumers who often seek out specialty flavors and the brand has been stepping up Gen Z and millennial-targeted promotional activity like Campbell Chunky’s new NFL metaverse game launched early this year. It remains to be seen what yields Campbell soup’s marketing efforts would deliver but it may help the brand gain favor among younger consumers and maintain its market leading position (the company has a 83% market share in condensed soups and 53% market share in wet soups), considering rival Progresso soup (owned by General Mills ( GIS )), does not appear to be as aggressive in capturing younger fans, an increasingly important consumer segment who should gradually overtake baby boomers in terms of disposable income along with increasing purchasing power and an increasing share of household numbers.

Execution, however, is key. Consumer packaged goods companies including Campbell's are generally perceived as purveyors of unhealthy processed food, a brand image Campbell's may take years to overcome and may thereby hinder their efforts to appeal to a younger demographic.

Campbell’s Snacks category however is a bright spot and prospects are cautiously optimistic. Snacking continues to remain popular (America’s snack sales were up 12% last year) and consumers continue to seek healthy alternatives to sugar-laden snacks. Campbell’s with its portfolio of differentiated savory snacks could remain a beneficiary of the trend. Riding on buoyant snacking trends, Goldfish crackers is on its way to being a USD 1 billion brand (accounting for more than 10% of revenues), and efforts to expand their target market from kids to adults (through efforts like new flavor launches and bigger-sized crackers) could further increase revenues.

Pretzels however are the star of the snacking market and likely to remain so, benefiting from consumer perception as a relatively healthy snack (being made with grains, low sugar and salt). Campbell’s which owns two of the top pretzel brands (market leading pretzel brand Snyder’s of Hanover as well as Snack Factory, among the leading brands in the premium pretzel segment) should continue benefiting. Good prospects for Campbell’s biggest snack brands which collectively account for around $1.5 billion dollars or more than 15% of revenues (Goldfish crackers is worth nearly USD 1 billion and Snyder’s of Hanover raked in more than half a billion dollars in sales last year) could support growth for the consumer packaged giant.

Expanding low-margin snacks business may offset cost saving initiatives

Campbell is on track to deliver $1 billion in cost savings by 2025, a positive for the company’s bottom line but likely offset by an expanding snack business which has a lower margin than their core Meals & Beverage segment (19% for Meals & Beverages versus nearly 15% for Snacks).

Campbell delivered $850 million in cost savings last year, but that didn’t necessarily translate into fatter margins; gross margins dropped to nearly 31% in FY 2022 from 33% in FY 2021. Net margins dropped to 8.8% in FY 2022 from 11.8% the previous year. Year to date, gross margins have held steady at 31% but net margins have dropped slightly to 9.4% this year compared with 10% the same period last year.

Risks

Competitive risks are significant particularly in the snacks sector which has a number of arguably better positioned snack giants. Confectionery titan Hershey ( HSY ) for instance is fast turning out to be a snack powerhouse and competing directly with Campbell’s in the fast-growing pretzels market. With 49% sales growth and 41% volume growth last year, Hershey-owned Dot’s Homestyle Pretzels is gaining market share at a rapid pace and the company continues to innovate aggressively recently showcasing it growing “ better for you ” snack portfolio, including permissible salty snacks, no-sugar-added, zero-sugar and plant-based snacks. Product synergies between its expanding snack portfolio may give Hershey a competitive edge over Campbell’s in the coveted pretzel space. Hershey’s chocolate-dipped pretzels for instance are enjoying robust gains in the U.S. (sales were up an estimated 10.6% last year to $79 million ) riding on the back of the popularity of its Hershey chocolate and Reese’s candy brands which the pretzels are coated with.

Conclusion

Analysts are mostly neutral on the stock.

Campbell’s price-driven growth is receding along with moderating inflation, and increasing competitor promotional activity along with tough comps could impact financial performance near term. Longer term, premiumization along the wellness and innovation lines and efforts to capture younger consumers could support growth in its core Meals & Beverages segment; however, these efforts are not new and with the soup and sauces market largely saturated in the U.S. (which accounts for more than 90% of total net sales), growth may remain tepid barring an unforeseen change in consumption trends. The snacks category has potential to deliver continued strong segment growth and may thereby help drive meaningful growth for the company overall but with a lower impact to profitability considering the segment’s lower margins. Competitive risks however remain from arguably better positioned players and execution risks are thus significant.

With a forward P/E of 15.1 , Campbell’s valuation is not particularly expensive, it trades at a discount to its five year average of 16, and is considerably lower than rivals like Hershey ( 25 ), and Mondelez ( 22.7 ). However, considering likely near term weakness as well as longer term competitive pressures from arguably better positioned rivals in the snacks market - Campbell’s current growth engine - the stock is not particularly compelling at this point and could be viewed as a hold.

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