2023-05-07 11:16:07 ET
Summary
- Campbell Soup is fully valued.
- The dividend yield needs to be higher since most of the returns in the stock are due to the dividend.
- Expect the stock to go sideways until the market volatility persists.
I rated Campbell Soup ( CPB ) a hold in December 2022 due to its lofty valuation. The stock has gone sideways since then, returning 3.6% (total return) compared to a return of 2.3% for the S&P 500 Index. This stock remains fully valued and would be rated a hold. The stock has to yield a dividend of 3% before I consider adding more to my portfolio. Most of the stock's returns in the past are due to its dividends, and investors should be uncompromising in expecting a good yield before investing. The company has strong brands, which the consumer loves, but short-term investors have taken refuge in the consumer staples sector and Campbell Soup during these volatile times. Long-term investors should wait for a pullback in the valuation of the consumer staples companies before buying Campbell Soup.
Price increases prop-up sales.
Campbell Soup reported excellent Q2 2023 results. The management grew organic sales by 13% and adjusted EPS by 16% (Exhibit 1) . The company's star performer is its Goldfish brand, approaching nearly $1 billion in sales (Exhibit 2) . Digging deeper into the results shows that all revenue gains come from price increases (Exhibit 3) . Sales volumes decreased revenue by 2%, while price increases contributed 14% to the sales growth. Many consumer staples and industrial companies have experienced lower price elasticities that have surprised the management. The snacking segment has been solid globally in the consumer staples sector. These lower price elasticities have emboldened management to increase prices by double-digits over the past year. But multiple things contributed to these lower elasticities.
Exhibit 1:
Campbell Soup Q2 FY 2023 Sales & EPS Growth (Campbell Soup Investor Presentation)
Exhibit 2:
Campbell Soup Performance of Goldfish Brand (Campbell Soup Investor Presentation)
Exhibit 3:
Campbell Soup Q2 FY 2023 Sales Bridge (Campbell Soup Investor Presentation)
Consumers were flush with cash from the pandemic-driven stimulus spending; the labor market has remained firm despite a record pace of rate increase. The massive inflow of Federal subsidies for green energy, electric vehicles, and semiconductors due to the Inflation Reduction Act and the CHIPS Act may be behind this tight labor market. Human psychology may have something to do with it. For example, spending $4 on a bag of snacks seems like a little, so most people spend their money on it.
Humans are not good at long-term planning, so they do not, for the most part, consider saving a little extra for retirement or an emergency. A $10 increase in grocery bills each week due to snacks may not seem like a lot, and they tend not to save that money for retirement. The lack of long-term thinking is why people spend a few hundred dollars each month dining out, buying snacks, and drinking Starbucks coffee. But, when money becomes incredibly tight due to reduced work hours or a layoff, people pull back hard on spending. In short, a confluence of events and human psychology led to lower elasticities. These elasticities will not last, and further price increases will be difficult to push through to the consumer.
Inflation leads to lower margins.
Gross margins were fragile in 2022, at 30.7%, compared to 33.2% in 2021 (Exhibit 4) . The company's gross margins had dropped from a high of 34% in 2020 when the pandemic-driven restaurant closures and work-from-home sustained demand. On the other hand, operating margins fared slightly better in 2022, increasing by ten basis points from their 2021 levels.
Exhibit 4:
Campbell Soup Annual Revenue, Gross, Operating Profits, and Margins (%) (Seeking Alpha, Author Compilation)
Operating cash flows were reduced in 2022 compared to 2019 and 2020 due to increased inventory costs (Exhibits 5 & 6) . The high inventory costs may be behind the gross margin erosion, and the company may have to contend with lower margins for 2023 as it sells its inventory. Overall, the company's inventory costs are normalizing after three uncertain years, which may be good news for its margins and cash flows, assuming inflation can be contained.
Exhibit 5:
Campbell Soup Operating Cash Flow & Free Cash Flow (Seeking Alpha, Author Compilation)
Exhibit 6:
Campbell Soup Day's Sales in Inventory (Seeking Alpha, Author Calculations.)
All gains have been had.
The stock's performance since the Q2 2023 earnings release on March 8 tells investors everything they need to know about its prospects. The stock was at $53.14 on March 8, and today, it trades at $54.63, a minuscule gain of 2.8% for what sounded like a resoundingly successful quarter. The Vanguard S&P 500 Index ETF ( VOO ) gained 4.1% during the same period. Most of the gains have already been had in this stock. The stock has gained 16% over the past year, while the Vanguard S&P 500 Index ETF was essentially flat with a gain of 0.19%. There may be little to no upside left.
Moreover, the stock has performed poorly over the long run (Exhibit 7) . The stock has trailed the 3-year, 5-year, and 10-year total returns compared to the S&P 500 Index. This emphasizes that investors may have to buy Campbell Soup Company at attractive (lower) valuations to earn decent returns. Some may argue that the technology giants (Microsoft ( MSFT ), Google (GOOG) ( GOOGL ), Apple ( AAPL ), Amazon ( AMZN ), Tesla ( TSLA ), and Meta ( META )) that are part of the S&P 500 Index fueled its rise during an era of zero Fed Funds rate over the past decade. That era is long gone, and this decade may belong to companies that generate good cash flows and pay a good dividend. They may be right, but the company may be fully valued, trading at 19x forward GAAP PE.
Exhibit 7:
The Vanguard Consumer Staples ETF ( VDC ) companies trade at a weighted average PE ratio of 24.7x, which is more expensive than Campbell Soup. The Vanguard S&P 500 ETF companies trade at a weighted average PE ratio of 20.9x. Large technology companies, such as Apple, Microsoft, and Amazon, trading at 29x, 32x, and 69x PE, make up 16% of the S&P 500 Index ETF. The company can grow its revenue at a low-single-digit pace over the long run. But the company still needs to generate consistent free cash flow growth over an extended period (Exhibit 5) . Ultimately, a company's cash flow generation powers and its growth will determine its value.
Modestly higher returns than the cost of capital.
The company's poor ROIC (Exhibit 8) reflects the lack of profitability growth, especially given that the cost of capital has increased dramatically for all companies globally. The company generated an 11% return in 2022, which may be barely above its cost of capital, which I estimate at 10%. The company barely generates a positive return on its capital. A company needs two critical things to generate good returns for shareholders: revenue growth and a return on invested capital above its cost. The company lacks good revenue growth, and its returns are poor. Assuming an 8% cost of capital, the company generates about 300 basis points in excess returns. The company's free cash flow is now back to its 2019 level (Exhibit 5) .
Exhibit 8:
Another interesting point about Campbell's total return is that most of its gains were driven by its dividends (Exhibit 7) . Over the past ten years, the stock has had a price return of 18.3%, while the total return was 57.1%. About 38% of the return was from dividends. Since most of its returns are from dividends, investors must aim for a good dividend yield when starting a new position or adding to existing holdings in Campbell Soup. At a price of $49, the stock would yield 3%, a good dividend yield based on its forward dividend of $1.48. The company has grown its dividend at a CAGR of 3.6% over the past five years and 2.5% over the past ten years. If inflation returns to the Fed target of 2% , the company's dividend may barely grow above the inflation rate.
Valuation
The stock looks overvalued, trading at a forward GAAP PE of 19x. The discounted cash flow model estimates a per-share equity of $50 (Exhibit 9) . This model assumes a 3% growth rate, an 11.2% free cash flow margin, the company's average over the past decade, and a discount rate of 8%. The discount rate may have to be higher given that its high debt-to-EBITDA ratio is 3.3x. But, given the nature of the company's business, it has dependable cash flows to service this debt. The company carried total debt of $4.5 billion and net debt (after cash) of $4.3 billion (Exhibit 10) . The company understands the risks of carrying high debt in this rate environment and has worked to reduce it. Since August 2020, the company has reduced its net debt from $5.3 to $4.3 billion at the end of its January quarter.
Exhibit 9:
Campbell Soup Discounted Cash Flow Model (Seeking Alpha, Author Calculations)
Exhibit 10:
The Campbell Soup company has a beautiful collection of timeless brands. Like many consumer staples companies, it has benefitted from lower price elasticity over the past few years. The dividend income may be the biggest reason to buy this stock, but the yield is low compared to the current rate environment, and the company has grown at an intense single-digit pace.
For further details see:
Campbell Soup: Waiting To Add More At A Fair Valuation