2023-07-17 23:22:00 ET
Summary
- Consumer Staples stocks have been underperforming in the US stock market, with Lamb Weston being downgraded from a buy to a hold due to signs of caution.
- Lamb Weston, a leading manufacturer of frozen potato products, trades at a high price-to-earnings ratio and pays a low dividend yield, but has shown strong technical momentum.
- Despite a solid Q3 performance, Lamb Weston's valuation is high and momentum is waning, leading to a recommendation to take profits and possibly buy on a retest to the mid-$90s.
- Ahead of earnings next week, I highlight important price points to watch on the chart.
Consumer Staples have been a steady slice of the US stock market over the decades. At 7% today, it is on the small side compared to historical averages as other growth-heavy areas have outperformed in the last decade. Even with the relative underperformance, the group trades about 20 times forward earnings estimates – slightly at a premium to the S&P 500. As a risk-on trading regime persists in 2023, Consumer Staples stocks have been underperformers for the most part.
One name, richly valued, has featured strong technical momentum. But I’m spotting signs of caution on shares of Lamb Weston ( LW ), leading me to downgrade the name from a buy to a hold.
S&P 500 Sector Slices: Staples Shrinking
According to Bank of America Global Research, LW was spun off from ConAgra Foods in November 2016. Lamb Weston is the leading manufacturer of frozen potato products, with over $3.5bn in annual revenues. The company is #1 in North America and #2 globally. The firm generates approximately 80% of sales in the US and Canada and 20% in international markets.
The Idaho-based $16.4 billion market cap Packaged Foods and Meats industry company within the Consumer Staples sector trades at a high 30.1 trailing 12-month GAAP price-to-earnings ratio and pays a low 1.0% dividend yield, according to Seeking Alpha. Ahead of earnings on the 25 th , the stock carries a modest implied volatility percentage of 25% and has short interest of less than 2%.
Back in April, LW reported a solid earnings beat . EPS for its Q3 verified at $1.43, topping estimates of just $0.99, while revenue rose 31% year-on-year to $1.25, also besting estimates. What buoyed the share price more so may have been the management team’s raising of the company’s estimates: EPS of $4.35 to $4.50 is now expected compared to the previous target of $3.75 to $4.00 (consensus of $3.94). Lamb Weston also named Mike Smith as the COO who may have his hands full as food inflation is now moderating, which could pressure the top line of firms like LW, so be watchful of margins in its upcoming quarterly report.
On valuation , analysts at BofA see earnings summing to near $5 over the coming 12 months (LW’s FY ends on June 30). The Bloomberg consensus outlook calls for slightly lower per-share profits in FY 2024 compared to BofA's projection. Out-year estimates show solid growth , though. With dividends expected to climb steadily, there is no doubt that LW is a highly profitable firm, though its free cash flow yield is not all that high. But with forward P/Es now in the mid-$20s, it is not in the bargain bin.
Lamb Weston: Earnings, Valuation, Dividend Yield Forecasts
If we apply a premium P/E of, say, 22 (given the robust growth trajectory) and assume next-4-quarter EPS of $4.70, then the stock should be near $103, or about 10% under today’s price. So, I reiterate my less-than-sanguine view of LW’s valuation.
LW: Pricey Valuations, But Solid EPS Growth Ahead
Seeking Alpha
Looking ahead, corporate event data provided by Wall Street Horizon show a confirmed Q4 2023 earnings date of Tuesday, July 25 BMO with a conference call later that morning. You can listen live here . No other volatility catalysts are seen on the corporate event calendar.
Corporate Event Risk Calendar
The Technical Take
Back in March , I highlighted LW as a big-time bullish momentum play. The idea worked out even though I viewed the valuation as rich. Today, however, momentum is waning in my view. Notice in the chart below that shares are struggling near all-time highs. The RSI momentum indicator at the top of the chart shows a series of lower lows even though price is holding steady in the $110 to $116 zone. Often in technical analysis, momentum is seen as turning before the price changes.
So, this is a warning flag. In the bulls’ corner, though, is the rising 200-day moving average as well as long-term support at the recent breakout area ($86 to $96). Furthermore, an uptrend support line that I pointed out last time is still in play. Overall, taking profits here might make sense, and buying on a retest to the mid-$90s may be the more prudent approach. If about $96 holds, then a bullish measured move price target to $140 is in play based on the previous $50 to $96 range/base breakout.
LW: Upside Breakout Was Successful, But Momentum Waning, Eyeing A Pullback
The Bottom Line
I am downgrading LW from a buy to a hold after a stellar performance run over the past many months. The valuation is high while technical momentum appears to be waning on this up-trending stock.
For further details see:
Lamb Weston: Fully Priced, Momentum Losing Steam (Rating Downgrade)