ConAgra Foods announced that it will sell off its loss-making private label business yesterday (30 June) in a move that, the company said, will help unlock value for its shareholders. But selling off private brands is about more than offloading an asset that is a challenging turnaround story. New CEO Sean Connolly insists it is about putting ConAgra back on the road to growth. Katy Askew reports.
Sean Connolly faced some significant challenges when he took the helm at ConAgra Foods earlier this year, not least of which was how to approach the group's sizeable – but struggling – private label unit.
Announcing its full-year results yesterday, ConAgra revealed that a 290% drop in full-year operating profit at private brands dragged the company's overall performance down. On a group-wide basis ConAgra said operating profit fell 82.2% to US$181.5m, despite a near 20% rise in operating profit at consumer foods and a 5.7% increase at the firm's B2B business Lamb Weston.
"While we have seen some bright spots over the past year – like the strong profit and margin improvement within consumer brands and the continued strong performance of Lamb Weston – those bright spots have been overshadowed by inconsistency, volatility and disappointments in our operating performance, particularly from private brands," Connolly commented during a conference call to discuss the group's result and update the market on the company's future strategic direction.
Clearly something had to be done.
Having completed his "detailed" review of the business, Connolly decided that quick and decisive action was needed "on a number of fronts" – the first of which was to commence the disposal of private brands "for greater focus".
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Overall, the market reacted warmly to the news. "ConAgra's decisiveness of announcing the exit of private brands is a good thing," Bernstein analyst Alexia Howard notes. However, she adds: "It could put the company in a more difficult negotiating position as the number of possible bidders for the business may be limited."
Indeed, some pundits warn that ConAgra could struggle to extract a good price for the loss-making private brands. Stefan Kirk, of M&A advisory Glenboden tells just-food: "Given the operating losses in ConAgra's private brands division, a strategic buyer's valuation would be largely driven by cost synergy calculations, as well as his view on additional 'one-off' charges. Those things are very hard to estimate; but generally ConAgra will be highly dependent on competition amongst buyers if it's to obtain a half-decent price."
While there could be some interest from private equity players, with much of the worth of the business coming from potential synergies, PE bidders could struggle to match the value placed on the unit by any potential strategic buyer. Meanwhile, Brett Hundley of BB&T Capital Markets, suggests that a spin-off doesn't offer "enough monetisation to ConAgra". While a trade buyer looks likely, there are a limited number of players likely to throw their hat in the ring, with TreeHouse Foods the likely front runner.
Connolly's own interpretation of the sale was – unsurprisingly – more positive. "This business has real potential and the private-brand segment of the retail class of trade continues to grow, but we have come to the conclusion that this asset will be more valuable outside of ConAgra Foods. We believe there will be significant interest from potential buyers to support a transaction that is acceptable in terms of value and structure," he insisted.
Nevertheless, with a limited number of buyers, ConAgra's private brands business might not be an easy sell. This said, the disposal is about more than extracting cash. It is about implementing Connolly's "overarching philosophy" of "value creation".
Connolly has formed the beginnings of a plan to get ConAgra back on the path to growth. This plan has largely been taken from the play book he followed to great success at Sara Lee, which later became Hillshire Brands.
"Aspects of the situation are not all that different from when I joined Sara Lee and led the transformation into Hillshire brands. There we turned an ageing and underperforming food company into a more energized, agile performer capable of creating significant value as a stand-alone company," Connolly noted.
At Hillshire, Connolly gave legacy brands fresh life, returning them to growth by modernising the portfolio through innovation. The company stripped away costs and improved efficiency. Management took steps to strengthen the balance sheet, providing financial flexibility that enabled the group to pursue on-trend M&A.
Indeed, Connolly did such a good job at Hillshire that the company ultimately became the target of a takeover battle that saw the business sold to Tyson Foods for US$8.55bn, or a hefty 16.7x EBITDA. ConAgra investors could well be hoping for Connolly to work the same magic, but, the chief executive cautioned, improvements will take time and there is no "overnight fix". He commented: "There are some things we will fully complete in fiscal 2016, but others will be a multi-year effort."
The plan consists of four stages: gain greater corporate focus through the sale of private brands; expand margins through a more "aggressive" approach to SG&A, trade productivity and supply chain; grow the remaining businesses through portfolio and capacity improvements; and maintain a "balanced capital allocation philosophy" that can support future M&A.
On cost reduction, Connolly indicated that four "levers" will be used to improve efficiency. The company will begin by assessing its operations through the lens of zero-based budgeting. It will seek out opportunities to "flatten" its organisation to "bring us closer to customers". ConAgra will also look at outsourcing to shift back-office work to third party providers who can deliver services at a lower cost. Finally, Connolly revealed, ConAgra will build a "performance culture" that will "create stronger accountability and a meritocracy mindset".
Connolly said he was optimistic on the potential on offer in ConAgra's stable of legacy brands – many of which are currently in decline. "On our branded consumer business, I like our prospects… we have several number one or number two brands and they are diversified across a number of large categories, many of which have distinct growth opportunities," he commented.
The company will identify areas in which to invest through marketing and innovation, while managing other brands for cash generation, Connolly continued. "We are the number-one player in single-serve frozen meals and continue to gain share in this attractive segment of frozen foods. We have good momentum in iconic category leading brands like Reddi-wip, PAM and Slim Jim. We have several strong scale brands, like Marie Callender's and Hunt's that are ready for and responsive to advertising and promotion, and we have reliable contributors that generate strong cash flow and margins. Consider Peter Pan, Manwich and Hebrew National."
In terms of innovation, Connolly revealed that the group will focus on three on-trend areas: "premium natural, ultra convenience and alternate channels".
While ConAgra "surgically" invests in areas that will be accretive to the top- and bottom-line, the company will also strengthen its balance sheet to support any acquisition opportunities that will unlock the growth areas of the US food sector.
Connolly elaborated: "We also intend to actively work toward filling in portfolio gaps in critical areas like organic natural and premium gourmet. In fact, we believe ConAgra Foods would benefit from further acquisitions in the consumer-branded space, given our scale and emerging capabilities. This point speaks to the need for us to maintain a strong balance sheet with ample firepower as we seek to balance returning capital to shareholders with investing back into the business and on strategic acquisitions."
An early sign of ConAgra's intent around M&A came in May, when the firm announced the acquisition of pot-pie maker Blake's All Natural. While the frozen food maker is small in terms of ConAgra's overall scale, the acquisition is significant because it unlocks the high-growth natural category and ConAgra plans to expand the business through picking up national distribution.
Change is underway at ConAgra. Selling off private brands is just the first step on a road that will see ongoing portfolio adjustments as the group's new CEO works to align the company with the major themes shaping the US food sector.