ConAgra Foods: Undervalued Despite Missing Targets

Packaged foods maker, ConAgra Foods (CAG), produces a diverse product set from Healthy Choice packaged meals to Slim Jim beef jerky.  The company reported fourth quarter and fiscal 2010 results on Thursday afternoon that on the face were not very impressive.  The company reported overall sales fell about 5% and quarterly profit slumped 48% as increased costs weighed down results.  However, this year the fourth quarter was one week shorter than the comparable quarter a year ago, so after adjusting for that and other one-time events the company said that profit would have been about even and sales would have actually posted slight gains.  However, the week-shortened quarter was incorporated into analysts’ estimates and on that measure the company failed to measure up albeit by a narrow margin.

Management was also conservative looking forward saying they expect earnings in fiscal 2011 will come in on the lower side of analysts’ forecasts even as they strengthen in the second half of the year.  ConAgra believes net income will rise between 8 and 10 percent in the current fiscal year, which equates to about $1.88 to $1.91 per share.  As of this morning, the consensus among Wall Street analysts was for $1.91 per share, so the guidance is a little bit of a disappointment.  Furthermore, the company expects to bring in $1.2 billion in cash flow from operations, while strong this would be a decline from fiscal 2010’s $1.4 billion in cash flow.

ConAgra suffered the worst sales declines in their commercial foods business, which supplies restaurants and institution’s cafeterias.  This division is responsible for about one-third of revenue, and the weakness in the restaurant industry has affected this business for some time now.  Furthermore, a poor potato crop this year boosted input costs and should continue to be a headwind going forward.  By comparison, the larger consumer foods division was stronger and increased sales 3% after adjusting for the one-week difference.  The consumer division has a strong presence in grocery stores and has benefitted from consumers tendency to eat at home more often since the recession began.

With conditions still difficult in the food service industry, some may be surprised that we believe CAG is currently Undervalued.  However, if you look at the way the market has historically valued ConAgra, we think it looks like the stock remains underappreciated.  Historically, the market has been willing to pay between 23x and 34.4x times cash earnings per share, but as the stock currently trades for only 12.8x the low end of 2011 expected earnings.  The stock currently trades at .84x times sales per share, which is within the historically normal price-to-sales per share range of .73x to 1.02x but closer to the low end.

ConAgra repurchased 4 million shares during the fourth quarter along and still has $400 million left on their repurchase authorization.  It does take a stretch to believe they will continue buy back shares next year as fundamentals improve, so the per share valuation metrics noted above would only benefit from such actions.  Based on the current fundamentals, we think that ConAgra could trade in the low $30’s before we would consider a downgrade.  So, we would recommend value investors consider this stock and look past the poor headline numbers; the market does not seem to mind them too much as the stock is down less than 1% after missing analysts’ targets.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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