Conagra investing behind ex-Pinnacle brand Gardein

Conagra investing behind ex-Pinnacle brand Gardein

Conagra Brands is seeking to seize upon opportunities in the meat-alternative market amid muted growth on its top line. Simon Harvey takes a look at the Birds Eye owner's latest financial results and the year ahead.

After what proved to be a difficult fourth quarter for Conagra Brands, the US food group is looking to innovation to turn around results in its new financial year with particular attention on the fast-growing plant-based category.

The owner of the Birds Eye frozen food brand (in the US) saw sales decline across all its business divisions in the final quarter as the company was hit by aggressive price-cutting from outside its walls. While that was only a factor described as "transitory" by Conagra, the company also witnessed a weak performance in its Ardent Mills flour joint venture with US agri-food giant Cargill and CHS, resulting in more plant closures.

Although no hint was made by chief executive Sean Connolly over the potential disposal of Ardent Mills one has to wonder if the project might be destined for the chopping block, joining the likes of frozen pasta business Gelit, and Wesson cooking oil, which were both sold in 2018.

And amid a slide in annual income and the payout to shareholders, Conagra restated its "long-term growth algorithm" having also missed its guidance for the legacy business. At the same time, Conagra's deal for Pinnacle Foods, sealed in October to create a major player in the frozen category, needs more time to deliver solid results as the new owner whittles down the portfolio to eliminate under-performing lines, while delving into product innovation to appeal to the new-age of consumers.

Could plant-based offer opportunity for Conagra?

But the growing plant-based market could hold potential as Conagra revealed its determination to gain a stronger foothold in the category through the Gardein brand inherited as part of the Pinnacle Foods deal. It is a segment being embraced by mainstream food companies to take advantage of increasing demand from consumers seeking to cut down on their meat consumption, whether it be for health or environmental reasons.

"Now that we own Gardein, we are very well positioned to capitalise on the explosive growth in this exciting space," CEO Connolly told analysts and investors on Thursday to discuss the company's fourth-quarter and full-year financial results. "Our disciplined approach to innovation and brand building, particularly across our frozen and snacking portfolios is paying off."

Whether Conagra can hold its own in the meat-alternative space is a matter of debate as it will be up against the likes of upstarts Beyond Meat and Impossible Foods, companies that have seen growing demand for their meatless burgers, while established players in meat-free products like Quorn Foods and some fellow major food names enter the category, including most recently Tyson Foods.

Robert Moskow, a consumer goods analyst at Credit Suisse, says Conagra may find the going difficult given the popularity of Beyond Meat's alternative burger. 

However, Connolly says Conagra sees more potential in chicken-alternative products, followed by pork, hot dogs and fish. 

Moskow writes in a research note: "Management highlighted a plan to use existing capacity for its Gardein brand to launch fresh burgers and hot dogs and co-branded frozen meals for Gardein-Healthy Choice and Gardein-Birds Eye. However, it was hard to see why retailers would want to put these Gardein products in the butcher case if they already sell Beyond Meat. Also, in our experience, co-branded products tend to confuse the consumer with multiple messages at once."   

And Credit Suisse also still has concerns voiced previously about the integration of Pinnacle Foods, and consequently lowered its target price on the shares to US$29. The stock closed at $26.90 in New York yesterday (1 July).

Moskow questioned "whether the brands in this portfolio are strong enough to maintain momentum during the complicated effort to turn around the acquired Pinnacle business". 

Conagra recognises the growth opportunities not just in the meat-centric space but in all foods containing animal proteins. Connolly said plant-based alternatives could achieve a 15% slice of both those markets, adding: "That means the opportunity here could be in the range of $30bn, just in the US. There's even more opportunity internationally". 

Connolly said on Thursday Gardein had "quadrupled in size over the past four years" and had generated sales of $170m in the year ended in May across the retail and foodservice channels. Conagra is increasing capacity to deal with the growth seen in the meat-free category and expects those to come on stream in the autumn. 

While Connolly said Gardein already has a burger in its range, it has been "underdeveloped" and is in the process of developing a "next generation of beefless burger to better compete in this popular segment".

He added: "As we do this, we expect accelerated growth at retail and in foodservice. But we also plan to compete across the important hot dog and sausage categories."

Conagra emphasises push on new products

Conagra also has innovation planned in snacks, sweet treats and frozen products. For the latter, it describes the push as the "strongest frozen innovation slate yet" across brands such as Marie Callender's, Healthy Choice and P.F. Chang's, while it also has a similar objective for snacks covering lines such as Slim Jim, Duke's and Angie's.

In salty snacks, it is rolling out new products into what Connolly described as "neglected and growing coves of the market, where we can extend our brands through innovation. With this innovation, we clearly have confidence that our snacking portfolio will maintain its momentum in fiscal 2020." 

Conagra says it is taking a "value-over-volume approach", a move that, in the short term, led to sales declines in some parts of the business as it cut "low-performing SKUs to clear the decks for our new innovations", particularly at Pinnacle Foods. 

The company had blamed its disappointing second-quarter results on the lack of innovation at Pinnacle Foods. The unit generated sales of $259m in Conagra's second quarter, a result Connolly said was below expectations "due to a weak performance across a range of significant brands". While group revenues rose 9.7% to $2.38bn, organic sales fell 1.6%.

Conagra is obviously taking steps to address the situation at Pinnacle. Connolly says the business "required more attention than originally anticipated" but has now delivered $31m in synergies since the deal was completed.

"I'm pleased to report that we continue to make progress stabilising the Pinnacle business," the CEO adds, naming the "big three" brands Birds Eye, Wishbone and Duncan Hines. "We've hit several key integration milestones and our deleveraging initiative is on track." 

Conagra cut its debt pile by $450m in the fourth quarter and $886m since the close of the acquisition, putting it on course to achieve its net debt-to-EBITDA target of 3.5 to 3.6 times.

Head of finance Dave Marberger put the estimated ratio for pro forma net debt to trailing 12-month adjusted EBITDA at 4.88 times as of the end of May.

Meanwhile, Moskow explains Credit Suisse's valuation on Conagra's shares: "Our $29/share target price is based on a 10.9x EV/EBITDA multiple against our fiscal year 2021 estimate. Our valuation assumes a 3% discount to closest food peers, in line with its 3% five-year average discount. Inability to deliver synergies as planned poses the biggest risk to our valuation due to the high degree of financial leverage."

Conagra had to weather price promotional activity during the fourth quarter, an issue which, along with unfavourable market conditions for the Ardent Mills venture, it called "transitory headwinds". The weak performance was put down to lower-than-expected wheat prices and a "lack of market volatility". 

The effects of competitor promotions were seen in the Hunt's, Chef Boyardee and Marie Callender's brands. And in the legacy Conagra business, the CEO says it missed its guidance by 240 basis points, equating to about $43m.

Some of our competitors "prioritised short-term growth via heavy promotion", Connolly explained, at the same time as Conagra raised prices on the back of inflation which ended up costing a loss in volumes. 

"We view this as a transitory renting of market share that happens from time to time," Connolly said, although there is no guarantee the price-cutting actions won't be repeated even if the CEO suggested they wouldn't be. 

"We continue to believe that profitable growth is key," he added: "And historically, aggressive pricing actions have proven to be unsustainable. But we will remain agile in the face of hyper-promotional behaviour by the competition and we'll tactically defend our share where it makes sense." 

Alexia Howard, a consumer goods analyst at Sanford Bernstein, says Conagra's legacy business is struggling and suggests weaknesses in the portfolio are "becoming more evident".

"Unexpected merchandising changes and elasticity-related declines in Hunt's ketchup (a distant number two brand) and Chef Boyardee (more heavily processed canned products) suggest that retailer negotiations are becoming tougher in these brands," she wrote in a client note last week. "This is a far cry from when Chef Boyardee was featured as a successful turnaround story on the 3Q:18 earnings call. Similarly, the lower-than-expected merchandising activity on Marie Callender's suggests that retailers may not be partnering as heavily on promotional activity as the company had expected due to intense competitive activity."

Digging into the numbers

On the financials, Conagra reported a 0.3% organic annual growth rate to $9.5bn in sales, although the metric dipped 0.7% in the final three months.

Attributable net income dropped 16% to $678m, while similar EPS earnings slid almost 24% to $1.53.

Meanwhile, Conagra made adjustments to its outlook for the current financial year and its longer-term growth algorithm to reflect the disposal of Gelit, which it sold to an Italian-led investor consortium in May.

Chief financial officer Marberger says results for the 2020 financial year are likely to be weighted toward the back half of the year. However, organic net sales growth will be more slanted toward the first six months on the back of investments. 

As a by-product of the Gelit disposal, Conagra raised its organic growth outlook from 1% to a range of 1-1.5%, and updated the adjusted EPS guidance to $2.08 to $2.18. 

Moskow was downbeat on the change in the guidance given the difficulties Conagra experienced in the fourth quarter, especially in price competition.

"We are also having a difficult time reconciling management's decision to raise organic sales guidance when it looks like it will need to respond to 'non-economic' promotions by competitors on several brands at once (Chef Boyardee, Hunt's, and Marie Callender's). At a time when investors are looking for consumer staples companies to de-risk their outlooks, Conagra appeared to increase the risk to theirs."

Under the three-year algorithm, organic net sales are expected to rise at a compound annual growth rate of 1% to 2% through 2022, while the adjusted operating profit margin is seen at 18% to 19%. Adjusted EPS should be around $2.68 to $2.78.

With Gelit now gone from the portfolio Conagra will have to come out with some strong product innovation to fill the void in terms of sales – Gelit generated $57m worth last year – especially if it continues to reduce the SKU count from Pinnacle Foods. And if it is intent on paying down debt, one has to assume that another part of the business might be let go.

Nevertheless, the plant-based food category has the potential to fill the gap, particularly if Conagra can grab a significant share of the market. And it is a category that until now had largely been underestimated, as Connolly himself admitted.

"I think we can all acknowledge that it was hard to see the consumer fever pitch for this space, gathering quite a head of steam it has done, and as quickly as it has done," the CEO says. "So, the upshot of all of this is that the market opportunity is quite a bit bigger than we're counting on. Does that mean that the investment behind it will be bigger? Potentially so to take advantage of it."