Campbell Soup Stock: Q3 Results And Debt Reduction Leave Shares Unattractive (NYSE:CPB) (2024)

Shares of Campbell Soup (NYSE:CPB) have been a poor performer over the past year, losing 15%, as elevated food inflation has weighed on consumer sentiment and volumes. While its acquisition of Sovos Brands will boost sales, it will take time to reduce debt back to targeted levels, meaning investor payouts are likely to be constrained. Given we are likely four years away from share repurchases and several years from dividend growth, CPB is likely to be dead money in my view.

In the company’s fiscal third quarter, Campbell Soup earned $0.75, which beat consensus by $0.05, as revenue rose by 6.3% to $2.37 billion. Organic revenue was flat with headline results boosted by the fact it closed its acquisition of Sovos on March 12^th. Sovos was EPS neutral in the quarter, better than expectations, driving much of the beat. Sovos adds Rao’s sauces and Noosa Yogurt to the meal & beverage unit.

Thanks in part to the acquisition, EBIT rose 13% to $354 million. Gross margins expanded 30bp, aided by its cost-savings program, though it continue to sees some inflation pressure. Marketing spend rose 2% to $198 million and administrative expenses were up 1% to $156 million. Both growth rates were slower than revenue growth, as CPB regains some operating leverage in its business, and a result, EBIT margin were up 90bps to 14.9%.

Organic volumes were flat, as were prices. Campbell saw industry volumes up 1.6% and price down 0.6% last quarter, an improvement from declining volumes last year when inflation caused consumers to pull back. CPB results outperformed peers on prices but underperformed a bit on volumes. Here, there is some bifurcation in its meals and its snack units, with meals outperforming. Snacks are more discretionary purchases, that consumers may pull back on. On the other hand, a more cautious consumer may choose to eat at home vs eat out, boosting demand for soup and other meal ingredients at the grocery store.

Indeed, grocery store inflation is now running meaningfully slower than restaurant price inflation, as you can see below. This adds to the relative attractiveness of cooking rather than dining out for cost-conscious consumers. Eating more at home is also a relatively painless way for consumers to tighten budgets. In some ways, CPB’s business is naturally hedged with its meals unit benefitting from a cautious consumer and its snack business more exposed to discretionary tastes.

Drilling into results, Meals & Beverages organic results were flat, but were up 5% pro forma for the acquisition of Sovos. Aided by Sovos, revenue rose by 15% to $1.3 billion, and given this sales growth, operating margins increased 160bps to 18%. Notably, soups added 0.3% of market share vs last year, aided by strength in broth and stocks. Now, broth is not a meal in and of itself; rather, it is typically an ingredient used in home-cooked meals. I view the standout strength in this particular product line as being supportive of the argument that consumers are shifting from restaurants to cooking more at home.

Alongside its existing brands, the Sovos product lines are performing well; Noosa Yogurt sales registered another rise, but the opportunity largely sits in Rao’s. Adding this to Prego gives Campbell a large and diversified sauce product line-up. Both brands are growing, and its sauce business added 3.1% of share vs last year. Leveraging Prego’s distribution and buying power with Rao’s well-regarded, more premium brand creates the opportunity for both cost and revenue synergies. Campbell is also seeing strength in Rao’s branded frozen food with pizza consumption up nine-fold as it expands distribution. With just 16% household penetration and Campbell’s significant distribution capacity, there should be a long runway for growth here.

Where we did see weakness was in snacks, which has brands like Goldfish and Pepperidge Farms. Snacks net sales fell by 1%, and revenue fell by 2% to $1.1 billion, given some lost pricing. As a consequence. margins of 15.2% are down 80bp from last year, though YTD margins are 40bp higher at 14.9% as we lapped weak quarters in early fiscal 2023 when cost inflation was particularly severe. I would note that snack sales are still up 6% from two years ago.

On the bright side, this two-years sales growth is indicative of its brands retaining share and consumer relevance, meaning more recent weakness is due to macro not idiosyncratic headwinds, a positive. On the more negative side, this two-year growth is a reminder that the absolute level of snack spending is still fairly robust. It was just extremely high last year, unsustainably so, and we are seeing some normalization. With spending still at an overall healthy level, I am cautious about the potential for a meaningful rebound even if the economy outperforms expectations. Moreover, there is the unknown “GLP-1” risk. As GLP-1 adoption continues to rise, there is a risk that calorie consumption declines across the country as weight loss pills reduce appetites. Snacking is particularly vulnerable to this trend. I am not expecting a sudden drop-off in demand, but this headwind when combined with a still-robust absolute level of spending leaves me expecting go-forward organic growth to be slow.

That brings me to the company’s guidance, which was noisy as Sovos Brands is now included. As you can see below, net sales growth was revised higher but organic growth and EPS were both reduced. Sovos is expected to boost sales by 4% and cut EPS by $0.01-$0.02. Its EPS midpoint was cut by $0.04, meaning the core business is also a little weaker as it cut its organic growth guidance due to a “discerning consumer” particularly at lower incomes.

While doing so, management did say it expects a recovery in the “first half of fiscal 2025,” which is the latter part of calendar 2024. I view this commentary cautiously. It is difficult to entirely buy into optimism about 6 months from now even as the outlook for the next three months has been revised lower. Moreover, as discussed above, snack spending is not particularly weak, when taking a step back, reducing the likelihood of a snap-back in demand in my view. As I do not expect a recession and with real incomes rising, I do not see results deteriorating further, but I am cautious about the rate of growth from here.

Finally, while the Sovos purchases adds high performing brands, it did significantly increase Campbell’s debt to $5.75 billion of debt from $4.5 billion, as such interest expense was $20 million higher last quarter at $66 million. Because it used debt to fund the purchase, its debt/EBITDA leverage is 3.9 from 2.6x last year. The company targets 3x debt/EBITDA by year three post close or 2027. That will be difficult to achieve. It would need to cut debt by $1.3 billion if there were no EBITDA growth. However with EBITDA likely to grow slowly (in the 2-3% range/year) as it continues to expand Rao’s product offering, CPB likely needs about $800 million to $1 billion of debt reduction.

CPB is about a $700-725 million free cash flow business. However, it also pays $445 million of dividends. That leaves it with about $270 million/year in retained cash flow. That means it can just about get to its leverage target by the end of 2027 by deploying all excess cash flow to debt reduction. If however, the business stalls or it mismanages Rao’s, it could take 4+ years to return to a target balance sheet.

As a consequence, I do not expect buybacks until 2028 at the soonest, and it will likely continue to maintain its dividend, rather than increase it. Investors collect a safe 3.4% yield, but it will take 3+ years to see any material increase in shareholder returns. That is a long time to wait in fairly slow growth business, with just a 5.3% free cash flow yield, debt-centric balance sheet, and near-term downside risk to snack consumption vs management commentary. With such a long horizon, CPB is likely to be dead money in my view.

Assuming a ~3% long-term growth rate, CPB can potentially generate market-like 8% returns with its 5% starting free cash flow yield. However, in the near-term, performance is likely to undershoot this given the need to reduce debt. Shares are not particularly expensive, but I see limited catalyst for multiple expansion given the need to prioritize debt over equity for several years. Just as it has in recent months, I expect shares to remain stuck in the $40-45 area and miss out on any market upside. With just a modest dividend and limited growth prospects, I would be a seller of CPB and move into companies with a clearer path to increasing shareholder payouts.

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