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Plenty of Value in ConAgra

Richard Saintvilus

NEW YORK ( TheStreet) -- Investors who are familiar with my writing should by now have a pretty good understanding that I get excited about mergers and acquisitions (M&A). I love deals of all sizes.

More important, though, I enjoy dissecting the long-term implications of the transaction not only between the two companies involved, but its potential ripple effect impacting upon rivals that are on the outside looking in.

In the case of ConAgra , there were more than enough reasons to cheer the company's $5 billion deal for Ralcorp. It was during a period of turbulence for the entire packaged-food industry, not to mention inflation had caused struggles for the likes of General Mills and Kellogg . This was a deal that I felt ConAgra needed to make -- even though I questioned the price tag, which included a 28% premium.

So far the results are paying off handsomely as ConAgra demonstrated in its recent fiscal fourth-quarter report. But I wouldn't get too excited about the gaudy growth numbers just yet. This was expected. In our last discussion, I said the following:

"Despite ConAgra's consistent fundamental improvements, the company should look much better once Ralcorp is fully integrated into the mix. To that end, investors should expect a leaner and more valuable company in the long term, provided that management is able to remove costs associated with Ralcorp, while improving asset utilization."

So far things are going according to plan. In some instances, ConAgra has exceeded expectations. Revenue was the biggest outlier in this recent quarter, growing 35% year over year. If this seems odd, it is. Or at least it should be after the company posted revenue growth of 13% in the previous quarter.

However, investors who have followed this name for a while should understand the strategies that have been at play here. The company has been growing revenue primarily due to acquisitions that were completed in the recent quarter. This quarter was no different as Ralcorp contributed to roughly 30% of the 35% growth.

This means ConAgra's organic growth would have come closer to the mid-single-digit range. Relative to expectations and peer performance this still would have qualified as a good sales quarter. But it's worth keeping things in perspective, especially when this quarter's performance can influence future expectations.

On a segmental basis, I don't believe there were any disappointments. The company posted 7% year-over-year improvement in consumer sales, helped by a 3% expansion in volume. In a sector that has been plagued by poor volume, I believe management did a good job in execution, especially given the 1% revenue opportunities that were missed due to pricing and product mix.

Likewise, I expect that bears will continue to press the issue regarding the company's margins without fully appreciating the disruption that large deals like Ralcorp are known to cause. But I believe the risk/reward is heavily tilted to the positive side. Although gross margin was flat along with a slight decline in operating margin, I would take that given that Ralcorp contributed to $962 billion in revenue.

It seems as if management is willing to sacrifice near-term margin for long-term growth. It's not a novel idea, but it's proven very effective. Other packaged food giants including Kraft and Nestle have gone through this same process. I've said it before and it's worth repeating -- with Ralcorp now secured, investors should expect a leaner and more valuable company in the long term.

I expect that management will figure out ways to remove costs associated with Ralcorp while improving asset utilization. But it's not going to happen overnight. When it does, margins will follow. In the meantime, I don't believe ConAgra should be criticized for any growth it is able to produce, whether organic or through acquisitions.

I don't believe it makes a difference in the grander sense unless you're scrutinizing an individual asset. With the continued fundamental improvements that I've detailed above, I remain a long-term bull on this company. The stock has traded relatively flat since I recommended it last quarter and until I see a meaningful drop in performance I have no reason to change my view.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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