CPB - Campbell Soup Stock: Is Sovos The Secret Sauce?

2023-08-08 13:08:14 ET

Summary

• Campbell Soup Company recently announced its acquisition of Sovos Brands for $2.7 billion, at a premium 3.2 times sales multiple.
• Sovos Brands, known for brands like Rao's and Michael Angelo's, generated $837 million in sales in 2022.
• The deal is expected to bring some growth momentum to Campbell Soup, but the near-term impact on earnings is uncertain, and does not move the needle for the investment case.

About a month ago, I believed that Campbell Soup Company ( CPB ) was kicking the can. This came after the company posted soft fiscal third quarter results , with price growth decelerating and volumes coming down even more, not boding well for the bottom line.

Fearing the outlook for 2024, and the long-term execution of the business, I felt it was a bit too early to buy the dip, as little could I have imagined that the business was in the process of making a significant acquisition. The purchase of Sovos is a meaningful deal, but while long term benefits are seen, the near-term impact (other than a big increase in leverage) is rather limited.

The Base Case

As referred to in greater detail in the July article, Campbell has divested lots of non-core assets, including the likes of Arnott's, Kelsen and Bolthouse Farms in order to become a pure play on snack & meals, and beverages.

As the business became more streamlined, Campbell generated $8 billion in sales pre-pandemic, with adjusted EBIT posted at $1.2 billion and earnings coming in at $2.50 per share. Net debt of $6.1 billion was relatively high with EBITDA reported at $1.6 billion, as leverage ratios came in at 3.7 times, with share trading in the low forties.

The company saw a strong 2020 amidst the hoarding effect related to the pandemic, with sales growing to $8.7 billion and earnings coming in at $2.95 per share. Moreover, net debt was cut further to $5.4 billion, as the strong 2020 created tough comparables for 2021 as struggles continued in 2022. The company posted fiscal year 2022 results in September of the year, with revenues up a percent to $8.6 billion, and earnings reported at $2.85 per share.

The 1% revenue growth for 2022 looked better than it was, as pricing drove the growth with an 8% contribution, while volumes and mix effects creating a 6% headwind to the business. For the fiscal year 2023, the company guided for a 5% increase in sales to $9.0 billion, with earnings seen at $2.90 per share, as the company hiked the guidance, seeing 8% revenue growth and earnings of $2.95 per share, following the first quarter earnings report.

Second quarter sales (reported in March) saw revenues up as much as 12%, while volumes were down 2%, as the company deleveraged further and hiked the guidance further. In July, Campbell, posted a mere 5% increase in third quarter sales, with pricing up 12% while volumes fell as much as 7%. This created a tough set-up with adjusted earnings coming down two pennies to $0.68 per share as the company was still on track to post an 8-10% increase in full year sales, with earnings seen between $2.95-$3.00 per share.

Moreover, net debt came in at $4.5 billion, as at $45 per share the earnings multiple stood at 15 times earnings in June. This looked interesting, but comes amidst a disinflationary environment, with headwinds seen for years now, making that I cut my entry point towards the $40 mark.

What Now - A Big Deal

Since last looking at the shares of Campbell in July shares have been trading around the $45 per share mark, despite a big deal being announced. Based on $4.5 billion in net debt and 301 million shares outstanding, the company commanded an $18 billion enterprise valuation, at roughly 2 times sales.

Early in August, Campbell announced that it has reached a $2.7 billion deal to acquire Sovos Brands ( SOVO ), a leading manufacturer of premium Italian sauces. With a $2.7 billion price tag, based on a $23 per share acquisition price, the deal comes at a premium.

Familiar from brand names like Rao's, Michael Angelo's and noosa, Sovos generated $837 million in sales in 2022 from selling pasta sauces, dry pasta, soups, frozen entrees, frozen pizzas, etc. This reveals that a premium multiple has been paid at 3.2 times sales, a 60% premium vs. Campbell´s sales multiple.

Part of that premium can be justified by strong growth, with flagship brand Rao (responsible for nearly 70% of sales) posting organic growth around 35% in 2022. The 19.8 times EBITDA multiple suggests that EBITDA comes in at $136 million, for margins which look fair at 16%.

Both companies expect $50 million in synergies over time, badly need to justify the premium valuation multiple. Nonetheless, no near term earnings contribution is expected, with earnings per share accretion seen in year two, unfortunately it has not been quantified how big this accretion is expected, but for the near term the incremental interest costs will exceed the earnings contribution.

With net debt used to finance the deal, I peg pro forma net debt at $7.2 billion. The company anticipates a leverage ratio of around 4 times upon closing, suggesting $1.8 billion in EBITDA which more or less adds up if we look at the EBITDA contribution of both firms, and the synergy projections.

A Final Word

Overnight, Campbell Soup has increased leverage substantially from about 2.8 times to 4 times, with no immediate earnings per share accretion to show for, in fact, likely the other way around. That said, the deal has the potential to bring some underlying (volume) growth momentum of the firm, although that with a $837 million revenue contribution, Sovos will contribute about 9% to pro forma sales. Even if its sales grow by 10% per year, that only adds about a percent to Campbell, a rounding error and likely offset by pressure on its own core business.

That being said, a 28% compounded annual growth rate number for period 2019-2022, as posted by Sovos, looks pretty decent to me, provided that Campbell leaves the growth story intact. For that it should not fall for the traditional mistake of trying to deliver on near-term cost-cutting efforts which will do more harm than good in the long haul.

Amidst the many moving parts, I am reiterating my take from July. While this is a strategically sound deal, the premium paid and higher leverage ratios assumed, on top of the fact that Campbell Soup Company shares needed to come in a bit before I saw appeal, mean that I continue to watch this one from the sidelines.

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