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Conagra Brands: High Inflation Leads to Long-Term Opportunity

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Conagra Brands Inc. (NYSE:CAG) is a consumer packaged foods company that operates predominantly in the U.S., where it generates over 90% of its revenue.

The Grocery & Snacks segment principally includes branded, shelf-stable food products sold in various retail channels across the country. Top brands include Slim Jim, Vlasic, Orville Redenbacher's, Reddi-Wip, Wish-Bone and Chef Boyardee. The Refrigerated & Frozen segment includes branded, temperature-controlled food products found the chilled or frozen aisles in most grocery stores. Top brands in this segment include Marie Callender's, Healthy Choice, Banquet and Birds Eye.


The Foodservice segment includes branded and customized food products, including meals, entrees, sauces and a variety of custom-manufactured culinary products packaged for sale to restaurants and other foodservice establishments.

With a history dating back to 1919, Congagra is expected to generate $12 billion in revenue and currently has a market capitalization of $16 billion.

Financial review

The company recently reported its fiscal year ending May 29, in which the company was able to post a reasonably successful year considering all the inflationary pressures and supply chain issues.

Although organic sales increased 3.8% for the year, the company noted cost of goods sold inflation of a remarkable 16.4%. This resulted in a gross margin decrease of 378 basis points to 24.8%. Adjusted earnings per share decreased 10.6% to $2.36 due to extraordinary margin pressures experienced during the year.

The company has typically delivered strong operating cash flows, which totaled $1.2 billion for the year and, after capital expenditures of $464 million, free cash flow was $713 million. Of that amount, $582 million was used for dividend payments.

Conagra Brands: High Inflation Leads to Long-Term Opportunity
Conagra Brands: High Inflation Leads to Long-Term Opportunity

Conagra has almost $9 billion in debt on the balance sheet, mostly attributed to the acquisition of Pinnacle Foods. The company acquired Pinnacle in 2018 in a deal valued at $10.9 billion including acquired debt.

Based on $2.2 billion in estimated Ebitda this year, the companys leverage ratio is approximately 4 times. Conagra's goal is to bring that down to the 3.50 to 3.75 range over time.

Valuation

The company provided guidance for the 2023 fiscal year, which included organic sales growth in the 4% to 5% range, an adjusted operating margin of approximately 15% and earnings per share growth between 1% and 5%.

Consensus analyst estimates for the fiscal year ending May 2023 are $2.44 and $2.59 for the following year. Conagra is selling at a reasonable 14 times estimated earnings, but because of its debt load, enterprise value/Ebitda may be a more relevant valuation metric at approximately 12 times.

The company pays an annualized dividend of $1.25, which equates to an above-average dividend yield of 3.71%. The payout ratio is slightly over 50% based on forward-looking earnings per share estimates.

Guru trades

Gurus who have recently purchased Conagra Brands stock include Ray Dalio (Trades, Portfolio) and Mark Hillman (Trades, Portfolio). Gurus who have sold or reduced their holdings include Mario Gabelli (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio).

Summary

Like most packaged food companies, Conagra is facing nearly unprecedented inflationary input costs that are squeezing margins and slowing growth. If the company can continue to generate organic growth, however, those cost pressures will alleviate at some point and margins will return to normal levels. This could possibly create double-digit operating income growth and large increases in free cash flow. As the company continues to generate larger amounts of free cash flow, it can reduce its debt levels and value will accrue toward equity holders when that occurs.

This article first appeared on GuruFocus.