We Don't Think Campbell's Sales Will Keep Growing at a Blistering Pace as Competition Intensifies
We Don't Think Campbell's Sales Will Keep Growing at a Blistering Pace as Competition Intensifies
Business Strategy and Outlook| by Erin LashUpdated Mar 12, 2021
Campbell, like its peers, has benefited from consumers staying close to home, with 95% of its sales being derived through the retail channel. However, we concede change was underway before the pandemic. More specifically, as CEO Mark Clouse laid out in June 2019, Campbell has abandoned its prior focus on extracting profits from its core soup lineup (starving the business of investment) and relying on acquisitions outside its core niche to bolster its trajectory (both key tenets of Denise Morrison’s model during her seven years as CEO). Rather, the firm now strives for profitable growth across its core meals and snacking niches by funneling additional spend behind its brands, which we perceive as prudent. So while we’re reluctant to believe the recent sales acceleration will persist over a longer horizon (as competitive pressures intensify and consumers venture outside the home for food consumption), we think the firm is poised to boast low-single-digit top-line gains the next 10 years.
Cost inflation and heightened expenditures stemming from COVID-19 (related to safety, sanitation, transportation, and logistics) also remain a challenge. However, we’re encouraged by Campbell’s focus on unearthing efficiencies, as part of its current initiative to generate $850 million in savings by the end of fiscal 2022. And we anticipate opportunities for further savings are likely in the cards, particularly within its supply chain and inventory management, which, based on management commentary, is still quite complex (with an astounding 1,300 facilities in its network currently housing inventory). But we don’t posit the bulk of any potential savings will merely drop to the bottom line. Rather, we expect fueling consumer-valued brand spend will remain a top priority, with our forecast calling for research, development, and marketing to exceed 7% of sales on average the next 10 years (a touch above the 6% levels expended the past three years). Beyond ensuring its fare stays in front of consumers, we also perceive this spending as an opportunity to ensure its entrenched retail relationships (a pillar of the brand intangible asset that underpins our wide moat rating) persist.
Economic Moat| by Erin LashUpdated Mar 12, 2021
In our view, Campbell has a wide economic moat resulting from brand intangible assets and a cost advantage. As such, we expect the firm’s returns on invested capital to remain above its cost of capital (even under a more bearish outlook) over the next 20 years. By operating as a leading packaged food manufacturer (controlling nearly 50% share of the U.S. soup aisle, according to Euromonitor), Campbell is a valued partner for retailers, in our view, supporting its intangible asset moat source. Further, the resources Campbell maintains to bring new products to market (spending just north of 1% of sales, or nearly $100 million, on research and development annually on average the last five years) and tout its fare in front of consumers (allocating nearly 5% of sales, or about $385 million, on average toward marketing each year) to drive customer traffic into outlets, enhances the stickiness of its retailer relationships. In our view, this positioning and its resources have enabled Campbell to maintain valuable shelf space for its offerings, even in areas like soup, where its share has been challenged by peers, lower-priced private-label fare, and smaller foes. While we don’t expect this competitive pressure to subside, we believe it is the strength of these relationships that ultimately should ensure Campbell's edge persists longer term. We also believe Campbell possesses a cost edge resulting from the economies of scale in production and distribution across its network, which has afforded it the ability to invest significant resources behind research, development, and advertising. We believe these factors have enabled Campbell to boast returns on invested capital (including goodwill) of approximately 15% on average over the past decade, which is more than double our 7% cost of capital estimate. We expect the firm will continue generating excess returns over our explicit forecast.
We think the firm's dominant position in U.S. soup, combined with investments to reshape its portfolio (most recently with the addition of Snyder's-Lance's portfolio of on-trend snacks and the sales of its fresh business and international operations), should enable Campbell to maintain its negotiating power with retailers. In our view, retailers prefer to stock brands that will drive traffic into their outlets but are reluctant to expend shelf space to unproven suppliers that likely lack the resources to satisfy supply chain needs. As such, we believe the firm’s portfolio mix shift toward more on-trend categories (like snacks) has been prudent, given that these offerings align with consumer preferences for healthy and convenient fare. We think Snyder’s-Lance is ahead of the trend with a portfolio that skews more to better-for-you snacking than the sector overall. When taken together, we believe Campbell’s intangible asset edge, borne of multicategory strength built on its pre-eminent soup offering and its brand dominance and favorable cost structure, attributable to its vast distribution network, should increase Snyder’s-Lance’s clout as the businesses are integrated.
Beyond the edge afforded by its intangible assets, we believe Campbell has a cost advantage stemming from economies of scale. Further, we contend that maintaining an entrenched supply chain creates a virtuous cycle, starting with scale, that affords manufacturers a mutually beneficial relationship with retailers, through which the vendor is an important retail partner, developing sales strategies to maximize volume and retailers’ margins while prioritizing its own brands. With its broad domestic manufacturing and distribution network, we posit that Campbell operates with lower unit and distribution costs, as well as greater supply chain efficiency and an enhanced ability to leverage brand spending, than smaller peers. We think that as a result of these cost advantages, Campbell maintains the ability to replicate competitive products and ultimately offer this fare to retailers at a lower cost. This stands to limit the potential shelf space (and scale) new entrants can amass. We believe it is this self-reinforcing combination of sources of Campbell's competitive edge that has created high barriers to profitable entry, shielding vendors that are entrenched in retailers' supply chains.
Fair Value and Profit Drivers| by Erin LashUpdated Mar 12, 2021
We're edging up our fair value estimate for Campbell Soup to $49.50 from $48.50 to reflect time value. Despite this, we still don't think its banner fiscal 2020 (that included 7% organic sales growth and 110 basis points of adjusted operating margin improvement to 16.7%) signals a sustained sales acceleration (prompted by increased at-home food consumption due to concerns over COVID-19) will manifest over an extended horizon. As such, we haven't wavered on our long-term forecast for about 2% annual sales growth longer term and mid-single-digit adjusted average earnings per-share growth over the next decade. Our revised valuation implies fiscal 2022 price/earnings of 17 times and enterprise value/EBITDA of 11 times.
Campbell's efforts to steady its footing have been facilitated by the sales of its fresh and international operations, which should enable it to focus its resources and personnel on its core businesses. Further, we still surmise the firm is poised to leverage its combination with Snyder's-Lance, given snacking is a business Campbell knows well (particularly with its Pepperidge Farms and Goldfish brands). We think this is a more poignant opportunity in light of consumers’ penchant for convenient, healthy fare. And we posit Campbell’s recipe for spicing up its product innovation and marketing support (particularly in its core soup niche, which had been starved of investment under former CEO Denise Morrison) should enable it to chalk up 1%-2% and 2%-3% annual segment top-line gains, respectively, in its meals and beverages and snack operations longer term.
From a profit perspective, we view the firm's aims to extract $850 million in costs as prudent, but think increased spending on sanitation and safety at its manufacturing facilities will serve as a near-term offset. Over the long term, we surmise Campbell will direct a portion of these savings to its brand spending in support of its competitive edge. We forecast marketing to tick up to nearly 6% on average over the next 10 years (above the 4.9% on average the last three years) and research and development to approximate 1.8% of sales (about $160 million a year, or about 60 basis points above the three-year average). This results in average operating margins of nearly 18% over the next 10 years (60 basis points above the prior 10-year average).
Risk and Uncertainty| by Erin LashUpdated Mar 12, 2021
As the leading global producer of soup, a highly profitable segment in packaged food, Campbell faces intense competitive pressure from its peers, which include General Mills, private-label fare, and other niche natural and organic offerings. Prior to the onset of the pandemic, ready-to-serve soup in particular had fallen victim to increased competition from other simple meal categories, and global category growth languished, holding about flat on average during the past several years. The rapidly evolving nature of consumer trends has proved challenging for Campbell, and the firm has been losing out to more nimble startups that have proved more agile in adapting their mix.
In this vein, we think the firm could resume the pursuit of select acquisitions or partnerships (similar to its purchases of Plum Organics and Pacific Foods) as a means to gain a greater understanding of changing consumer tastes and preferences (once it steadies its ship now that leverage has been lowered). However, deals could prove less beneficial if the firm is forced to pay an excessive premium or stumbles in the integration, particularly if it opts to venture further beyond its core soup niche.
Volatile input costs can also weigh on profits, and if Campbell chooses to raise prices to offset these pressures, volume could be constrained, especially during economic periods when consumers are highly selective in their purchase decisions. As such, Campbell had been opting to allocate a portion of its consumer marketing spending to promotions in an effort to prop up volume in soup and beverages as well as its Pepperidge Farm snacks and bakery lineup. Despite this, we still believe promotions aren't a sustainable or profitable way to expand the business over the long term. Further, with over 40% of its sales resulting from its top five customers (just more than 20% from Walmart alone), Campbell is exposed to retailer consolidation.
Stewardship| by Erin LashUpdated Mar 12, 2021
Our capital allocation rating for Campbell Soup stands at Standard, reflecting its sound balance sheet, investments that have proven fair, and appropriate shareholder distributions.
After its $6 billion transformational tie-up with Snyder's-Lance (inked in late calendar 2017), Campbell's debt load jumped to 5.8 times on an adjusted EBITDA basis. Despite this, Campbell has continued to prioritize debt paydown (which has included directing funds from the sale of its international and fresh operations), such that debt/EBITDA stood at less than 3.5 times at the end of fiscal 2020. With no debt maturities the next two years ($1 billion in debt matures in fiscal 2023), combined with its low revenue cyclicality and operating leverage, we don't surmise Campbell's debt balance will impede its ability to reinvest in its business while also funneling excess cash to shareholders.
In light of the stagnant prospects for growth in the center-store cateogries Campbell played (namely soup), the firm embarked on a course a number of years ago to diversify away from the challenged soup category, primarily by pursuing inorganic opportunities (with the deal for Snyder's-Lance marking its sixth over the prior five years). But we don’t believe this signals that Campbell is veering away from being a prudent capital allocator. Returns on invested capital have exceeded our cost of capital estimate in each of the past 10 years, and we forecast that the firm will continue to generate returns on invested capital in excess of our cost of capital estimate over our 10-year explicit forecast.
However, since CEO Mark Clouse took the helm two years ago, the firm has abandoned its outsize emphasis on extracting profits from its core soup lineup (starving the business of investment) and its reliance on acquisitions outside its core focus to bolster its trajectory (key tenets of former CEO Denise Morrison’s model during her seven years leading the charge). Rather, management’s updated playbook is anchored in driving profitable growth across its core meals, beverages, and snacking niches, which strikes us as prudent.
While we surmise management's focus will remian anchored in steadying its underlying operations over the next several years, we wouldn’t be surprised if the firm ultimately regained an appetite for acquisitions at some point down the road (once leverage levels have approached the firm’s 3 times target). However, we expect any potential tie-up will generally center on smaller, bolt-on deals that are unlikely to move the needle on its financial performance. From our vantage point, the benefits stem from adding niche businesses to its mix extend beyond enhancing its category exposure or capabilities. Rather, we believe smaller niche operators have demonstrated an ability to be more agile in adapting their mix to changing preferences. As such, we perceive tie-ups with these operators as potentially affording Campbell the opportunity to extract insights into how to respond to evolving consumer trends in a timelier fashion. We think the inability to do so has plagued firms throughout the grocery store and view efforts to grease the wheels of its innovation cycle positively.
But we don't think such efforts would stand to limit Campbell's ability to return cash to shareholders. In this manner, we forecast that Campbell will grow its dividend at a mid-single-digit clip annually through fiscal 2030 (maintains a payout of around 50%) while also repurchasing around 2%-3% of shares outsnading (which we perceive as prudent when executed at a discount to our assessment of intrinsic value).