Conagra Should Continue To Benefit From Supply Chain Optimization Efforts

Equity Analyst

Zain Akbari

Revenue segments as reported by the company.

Grocery & Snacks

Refrigerated & Frozen

International

Foodservice

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When CEO Sean Connolly was brought in to turn around a struggling Conagra in 2015, he implemented a new brand building strategy referred to as the Conagra Way. The process calls for using data to identify product attributes that are driving growth and designing products to reflect those traits. The strategy also increases the productivity of marketing investments by shifting spend to the more efficient digital channel and to higher potential brands. In addition, the firm has significantly reshaped its portfolio inorganically, shedding non-branded or noncore businesses and acquiring brands that enhance the firm’s growth and/or profit margins. As a result, in recent years, sales have inflected from declines to growth, and from market share losses to modest gains. We think the pandemic, which resulted in four and a half years' worth of incremental new buyers and saved the firm hundreds of millions of dollars in customer acquisition costs, will accelerate the benefits Conagra is reaping from these efforts, as many new consumers have been exposed to its new fare. Once the food retail market normalizes post-pandemic, we think Conagra can realize 2% annual organic sales growth. In addition, Conagra has identified over $1 billion in supply chain savings to be realized by fiscal 2025, which should result in operating margins that reach 18% over the long term, up from the 15.4% metric realized in fiscal 2019, before the pandemic and its aftershocks disrupted the market.

Despite these efforts, we think an enduring competitive advantage via its brand assets or entrenched retail relationships remains elusive. Admittedly, Conagra holds multiple market-leading brands, which makes it an important partner to retailers. However, its commitment to maintaining below-average investments in marketing (about 2.2% of revenue on average over the past three years compared with the 4.6% peer average) and research and development (0.5% of revenue compared with the 0.8% peer average) fails to give us confidence that Conagra's preferred status with retailers would persist over the next 10 years, as required for a narrow moat designation.

Business Strategy & Outlook

Conagra maintains market-leading brands in several categories, making it an important partner for retailers. Even so, given Conagra’s ongoing under-investments in marketing and innovation relative to its peers, we lack conviction that Conagra can maintain this leadership position for the next 10 years, as required for a narrow moat designation. As such, we think Conagra has failed to secure a moat.

Although we rate Conagra no moat, we acknowledge many positive changes implemented in recent years, which have improved the growth and profitability of the business. Sean Connolly was named as Conagra’s CEO in 2015 and was charged with stabilizing a business that had been experiencing market share losses and lagging operating margins (high-single digits, which were well below the mid- to high-teens level realized by many packaged food companies). In relatively short order, Connolly implemented the Conagra Way playbook, a series of repeatable processes that significantly changed the firm’s approach to brand building. Whereas Conagra’s innovation process was historically focused on gathering consumer insights through consumer surveys and panels, Conagra’s product development process now utilizes more predictive and reliable behavioral data to identify growth pockets and the attributes driving it. We think this approach is superior to traditional methods, as there can often be a disconnect between what consumers say and what they do. Further, while previous marketing strategies were heavily reliant on discounting (creating a push), Conagra now focuses on techniques that help build long-term brand equity (creating a pull), such as in-store displays, signage, sampling, and online merchandising. Conagra also modernized its advertising approach, which had been slow to evolve to digital mediums, a more relevant and effective way to reach and target consumers, as consumers have been spending more time using digital media in lieu of traditional forms such as broadcast TV, radio, and print. Further, digital ads generally have much higher return on investment, as they can be more targeted due to the availability of data on specific user behavior, which increases the probability that the ad will result in a sale. Conagra uses the digital platforms of its retail partners, which allows it to collect data on 90% of U.S. consumers, and utilizing retailer data, target consumers identified as likely to purchase Conagra’s categories. For example, Conagra will advertise Healthy Choice to consumers who have purchased Nestle’s Lean Cuisine. And the ad’s message will be customized based on the consumer’s previous purchase patterns ("options for a low carb lifestyle" or "flavorful, meatless meals" for instance). In 2015, Conagra spent just 28% of its media on digital and 72% on mass. In the first half of fiscal 2020, shortly before the pandemic struck, Conagra allocated 81% of its media budget to digital formats and just 19% on mass. Between 2017 and 2019, this shift helped drive penetration of Conagra’s frozen single serve meals and snacks into 1.3 million and 1.4 million additional households, respectively. We do not suggest that all of these methods are unique to Conagra, but as Conagra has now modernized its brand building approach, we have more confidence that Conagra can continue to remain relevant with consumers.

We believe the new approach is working, though we don’t ascribe to the notion that this improvement has merely been a byproduct of the pandemic. For one, its product innovation was hitting the mark even before COVID-19 came on the scene. More specifically, according to IRI, Conagra’s innovations have been outperforming that of competitors in the firm’s largest category, frozen ready meals, which represent a quarter of company sales, by our estimate. Of the top 10 better-for-you frozen single-serve meal launches in the 52-weeks ended January 2020, seven were Conagra’s Healthy Choice brand. And Conagra’s innovations are also outperforming in the indulgent frozen single-serve meals subsegment (where Marie Callender’s, Banquet, and Hungry Man reside), where Conagra drove 35% of this sector’s innovation sales, much more than the 23% we estimate was driven by Nestle, despite Nestle maintaining higher market share in this sub-segment (49% versus Conagra’s 31% by our estimates). Since the pandemic took hold, not only is Conagra realizing significant growth, as all packaged food companies are, but it is also outperforming its competitors. In its May-ended fiscal 2022, Conagra increased its aggregate category-weighted market share by 20 basis points, continuing its recent trend (in the past few years) of growing share by 20-30 basis points annually. Beyond Birds Eye, Marie Callender’s (8% of sales), Banquet (8%), and Healthy Choice (7%) have all demonstrated household penetration and repeat purchase rates that exceeded those of their largest competitors, implying that this momentum should continue, at least in the near term. We attribute these share gains to a successful innovation strategy, as 17% of sales stem from new products launched over the past three years, up from just 9% in fiscal 2015, and above the firm’s 15% goal and that of many peers (this statistic ranges from 5% to 17% for North American packaged food companies). 

Conagra has also been reshaping its portfolio inorganically, which we think has materially improved Conagra’s growth and margin profile but has not resulted in a moat. Since Connolly took the corner office, the firm has aggressively shed its non-branded businesses (private brands, commercial spices, distribution, frozen commercial potatoes) and purchased several branded companies that boast attractive growth and/or margins, within the firm’s areas of focus, frozen foods and snacks, which we’ve viewed as prudent. Most notably, in fiscal 2019 Conagra acquired Pinnacle Foods for $11 billion. While this acquisition brought significant goodwill, which is depressing ROICs, the deal also brought many leading brands, such as Birds Eye, the top-selling brand of frozen vegetables, Duncan Hines, the second most popular cake mix brand, Gardein, the third most popular brand of plant-based meat, and several smaller on-trend brands such as EVOL (frozen foods with natural, simple ingredients) and Glutino and Udi’s (gluten-free). Conagra has continued to actively reshape its portfolio with smaller transactions in fiscals 2020 and 2021, having recently divested brands that are not competitively advantaged, in our view, such as Peter Pan (the fourth ranked peanut butter with 6% market share per Euromonitor), private-label peanut butter, Egg Beaters, Lender’s bagels, and H.K. Anderson. We think these actions leave it with a strong portfolio of brands, and an improved growth profile, as we estimate Conagra’s current weighted average category growth rate is now about 2.4%, a significant improvement from the 1% rate we estimate the firm experienced before the reshaping. However, the additional goodwill from the acquired businesses is pressuring Conagra’s return on invested capital. 

In dissecting its brand mix, we estimate that 77% of Conagra’s sales stem from brands that hold a top two spot in their respective categories, up from just over half of its revenue base before the portfolio reshaping. According to Euromonitor, in the U.S., Conagra holds second position in popcorn (6% of company sales), with 17.8% market share in 2022 (estimated), compared with 20.5% for Frito-Lay and 17.3% for Hershey (Skinny Pop). Reddi-wip (4% of sales) is the number one brand of whipped cream, while Snack Pack (2%) is the top brand of shelf-stable dairy desserts. Conagra is the number two player in frozen ready meals (26% of sales) with 16.3% market share compared with Nestle’s 18.5%. Birds Eye (13% of sales) holds a 28.4% share of the frozen vegetable category, behind private label’s 42.8% share while Slim Jim (6% of sales) is the number two meat snack with 18% share, behind Jack Link’s 49.6%. Conagra also holds the number two spot in shelf-stable ready meals (Chef Boyardee), shelf-stable processed red meat (Armour Star and Libby’s), pickles (Vlasic), shelf-stable tomatoes (Hunt’s), cake mix (Duncan Hines), frozen processed red meat (Brown N Serve), frozen desserts (Marie Callender’s), soy sauce (La Choy), and hot cocoa (Swiss Miss). We think Conagra’s leadership in these categories, which represent a material portion of total food sales, elevates the firm to strategic partner status with the firm’s retail customers, allowing Conagra to secure favorable shelf space for its products, including new products the firm routinely launches. However, given Conagra’s under-investment in its brands relative to peers, we think it will be difficult for Conagra to maintain this strategic status for at least 10 years, as required for a narrow moat designation. Over the long term, we think Conagra will invest 2.4% of sales on marketing and 0.6% on R&D, less than the 5% and 1%, respectively, we expect its peers to invest. 

Assessing Conagra’s pricing power is complicated by the implementation of the firm’s value-over-volume strategy over the past five years, which eliminated uneconomic promotions, making price increases appear more robust than they would have been otherwise. But we see anecdotal evidence that suggests consumer perceptions of some brands are stabilizing, or even potentially improving. For one, the company confirms that it consistently and successfully passes cost inflation through to customers, which differs from the past when Conagra reported difficulties passing inflation through to retailers. In addition, there has been some examples of Conagra’s brands effectively trading customers up to more premium price points. For instance, while Conagra’s Banquet brand is positioned at the value end of the frozen ready meals category, Conagra launched a more premium positioned Banquet ‘Mega’ line, which sells for $0.17 per ounce compared with $0.14 per ounce for the traditional line. The Mega line extension has been very successful, growing to a $150 million line in the few years since it launched. 

Without sufficient product differentiation, pricing power can be difficult to obtain in categories with a material private-label presence. Given Conagra’s significant portfolio reshaping, we think that less than 40% of Conagra’s U.S. sales stem from categories in which private brands have a significant presence, down from about half of its sales base in recent years, although this is still significant exposure. Conagra’s largest categories with meaningful private-brand presence are frozen vegetables, butters and spreads, whipped cream, pickles, seeds, and shelf-stable tomatoes. We think this pressure is reduced as most of Conagra’s exposure in these categories resides at the high end and mid-tier price points, not on the value side, where brands can be squeezed out of the market when competing with a strong private-brand presence. 

In addition to moats rooted in intangible assets such as brand strength or entrenched relationships with retailers, consumer products companies can also secure a competitive edge based on a cost advantage. However, we do not see evidence to suggest that Conagra has secured a moat based on a superior cost position. Conagra's management has also expressed this view, believing the firm's cost profile is similar to that of their branded competitors; Conagra's management does not view the firm as cost advantaged or disadvantaged. Cost advantages often lead to superior profit margins, but we think Conagra will report high-teens average operating margins over the next decade, in line with most of its competitors. We suspect Conagra’s numerous divestitures have helped the firm simplify its operations, as it now participates in fewer, more focused categories. While we think these efforts enable Conagra to operate more competitively, we do not think it has led to an advantaged cost position.

Finally, when a firm consistently reports economic profits (ROIC in excess of its weighted average cost of capital), it suggests quantitative evidence of a competitive advantage, in our view. In the past seven years since Conagra spun off the Lamb Weston business, the firm reported economic profits in every year except 2022, which was fraught with cost inflation and supply chain inefficiencies. Conagra’s ROICs including and excluding goodwill have averaged 8% and 21%, respectively, over the last five years, both in excess of our 7% estimate of the firm’s cost of capital. However, the 2019 acquisition of Pinnacle Foods has caused Conagra’s consolidated ROICs including goodwill to fall from 10% to 7%-8%, given the lower returns of the legacy Pinnacle business and the addition of goodwill. Over the next five years, we expect Conagra’s ROIC including goodwill will average 8.6%, which is marginally above our 7% WACC estimate. The relatively low spread, though, reduces our confidence in Conagra’s ability to report consistent economic profits going forward, (especially as we think additional acquisition could further depress ROIC), supporting our no-moat rating.

None

Economic Moat

Conagra Brands

Conagra Brands, Inc. engages in the manufacture and sale of processed and packaged foods. It operates through the following segments: Grocery and Snacks, Refrigerated and Frozen, International, and Foodservice. The Grocery and Snacks segment includes branded, shelf stable food products sold in various retail channels in the United States. The Refrigerated and Frozen segment is composed of branded, temperature-controlled food products sold in various retail channels in the United States. The International segment offers branded food products in various temperature states, sold in various retail and foodservice channels outside of the United States. The Foodservice segment focuses on branded and customized food products, including meals, entrees, sauces, and a variety of custom-manufactured culinary products packaged for sale to restaurants and other foodservice establishments in the United States. The company was founded by Alva Kinney and Frank Little in 1919 and is headquartered in Chicago, IL.

Earnings data Q2 2023

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CHICAGO , June 7, 2023 /PRNewswire/ -- Conagra Brands, Inc. (NYSE: CAG) will host a webcast and conference call to review its fiscal 2023 fourth quarter results on Thursday, July 13, 2023, at 9:30 a.m. ET. The company's news release will be issued at approximately 7:30 a.m.

CONAGRA BRANDS ANNOUNCES DETAILS OF FISCAL 2023 FOURTH QUARTER EARNINGS RELEASE, WEBCAST AND CONFERENCE CALL

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