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Risk-Reward With Campbell Soup

- By Jonathan Poland

Campbell Soup Co. (CPB) is an iconic American brand with a history that dates back almost 150 years. The company isn't just in the soup business -- it has a corner on many sections of the supermarket with brands like Pace, Prego, V8, Pepperidge Farm and Swanson, to name a few. Add to those snack foods with the acquisition of Snyder Lance. Chances are if you shop at a grocery store other than Whole Foods, you're going to buy a Campbell product.

Of course, not everyone thinks that Campbell is on solid footing. Bloomberg took a look at 50 of the biggest deals in the last five years and found that many companies (including Campbell Soup) pushed debt to levels typically rated as junk, but that both rating agencies, Standard and Poor's and Moody's, had allowed them to remain "investment grade." This is a $1.9 trillion problem according to Bloomberg.

It's true that Campbell Soup borrowed $6 billion to buy Snyder's, which more than doubled its debt load, now sitting at more than five times Ebita. In fact, the company's debt load is over 12 times its projected net income for 2019.

When money is cheap, companies tend to make bad decisions regarding borrowing, and in this case, that's what happened. Yet, on the other hand, that deal was necessary for the company, which has struggled to grow organically while costs continue to rise. This is apparent from the degradation in the company's gross margins, which have fallen 7.5% over the last decade.

The debt load is forcing the company to make asset sales to cut its leverage ratio to 3x Ebita and try to maintain its credit rating. If that debt moves into junk status, the bonds will likely be a better buy than the stock. In either event, Campbell Soup's future is not in doubt. That's what matters the most. People that shop at major grocery stores will continue to buy its products for decades to come.

This year, the company will see a massive boost to earnings thanks in part to the deal with Snyder's. Then, over the next five years, earnings growth should stabilize around 5% a year. That means by 2023, earnings per share could be close to $3.25. However, even with an earnings multiple of 15x, the stock would only price around $50 a share. That's still not enough potential to pay for the massive debt at its current equity value.

Campbell Soup may have a wide moat, but investors have much better options with Kraft Heinz (KHC) and General Mills (GIS), both of which generate much better profit and carry far less debt.

Disclosure: I am not long/short any stock mentioned in this article.

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This article first appeared on GuruFocus.