In this screen, we focused our attention on high-quality stocks that also offer worthwhile price-appreciation potential to 2016-2018. For starters, we restricted our search to equities that get our Highest Rank (1) for Safety. Within our universe of roughly 1,700 stocks, only about 120 meet this criteria. The two key components that determine our rankings are Financial Strength and Stock Price Stability. Notably, investors who put the most emphasis on these qualities are typically willing to sacrifice some long-term total return potential in return for the added downside protection that these equities afford.
Not surprisingly, issues ranked Highest for Safety typically don’t screen well for 3- to 5-year price appreciation potential. As it stands today, roughly 15 offer long-term price appreciation potential that exceeds 50%, the current median for the Value Line universe. To add a value element, we narrowed the list further to companies with price-to-earnings multiples below 15. The 9 that made the cut can be found on the list below. Of these, we have chosen to highlight the shares of ConAgra Foods (CAG).
ConAgra Foods is one of North America’s leading food companies. Its Consumer Foods unit (58.5% of fiscal 2013 total sales) includes branded, and customized food products that are sold in various retail and foodservice channels. The Commercial Foods unit (33.3%) provides foodservice, food manufacturing, and industrial customers with specialty potatoes, milled products and seasonings, blends, and flavors. In 2012, the company acquired Railcorp, a maker of private label goods. Its segments are Railcorp Food Group (6.0%) and Railcorp Frozen Bakery (2.2%). Overall, the company’s major brands include but are not limited to: Healthy Choice, Hunt’s, Marie Callender’s, Orville Redenbacher’s, PAM, Reddi-wip, Swiss Miss, and Chef Boyardee. Wal-Mart (WMT - Free Wall-Mart Stock Report) is the company’s largest customer, accounting for 17% of total sales.
The company recently reported fiscal first quarter results that missed expectations. Management had been calling for flat earnings on a year-over-year basis, but the actual results were 16% below last year’s tally. One of the reasons behind the decline was the impact from losing a major customer in its frozen potato business. The other was more intense price competition in its consumer foods unit, which caused organic volumes to fall 3%.
The company plans to get the consumer business back on track by shifting some of its advertising dollars toward merchandising efforts. This will allow ConAgra to focus on high-margined items, optimize promotional activity, and better align the price/perceived value equation. Importantly, ad spending will not be reduced for brands that have benefitted the most from large marketing budgets.
The company had a few underwhelming product launches (Marie Callender’s Breakfast Sandwiches and Orville Redenbacher’s Pop Crunch) due to the assumption that consumers would be willing to pay premium prices. This caused half of the 22% decline in the Consumer Foods unit’s operating earnings. No major product launches are scheduled for the remainder of fiscal 2014. The revised pricing for newer and existing brands probably won’t meaningfully improve earnings until after the November quarter is over. In fact, earnings per share in the fiscal second quarter are expected to be flat to down slightly on top of a strong quarter in the prior year.
The company is anticipating a major earnings rebound in the second half of fiscal 2014. Most of this won’t come from renewed consumer volumes, however, as they are expected to only be flat. Instead, SG&A cuts, synergies realized from the acquisition of Ralcorp, and lower-than-expected cost inflation should drive the bottom line gains.
While the company is on track to increase EPS by $0.25 this year thanks to the Ralcorp acquisition, the most significant revenue and cost synergies from the deal should materialize in the 2015-2017 time frame. CAG expects $300 million in annual pre-tax savings by 2017.
Elsewhere, the company is contributing its milling operations (currently part of the Commercial Foods Segment) to a joint venture with Cargill and CHS called Ardent Mills, where it will have 44% ownership. The combination should help make the supply chain more efficient and provide a cash infusion that ought to accelerate the debt repayment over the next two years.
Although near-term results may turn out to be sluggish at ConAgra, the plan to reverse the weak volumes and cut costs appears sound. The company is on track to meet its Ralcorp cost savings goal. We think these shares are suitable for patient, conservative investors.
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At the time of this article's writing, the author did not have positions in any of the companies mentioned.