When we initiated coverage of the consumer staples sector earlier this week, we suggested that consensus EPS estimates were too low for CAG. This morning’s reported results bear out that position, in part, as CAG reported Q2 EPS of $0.57 versus consensus of $0.55. Additionally, the company raised EPS guidance from $2.03 - $2.06 to “at least” $2.06. Our forecast remains above that at $2.11. The increased guidance comes without the benefit of share repurchase as the program has been suspended with debt reduction becoming the preferred use of cash as the company digests the RAH acquisition (calendar Q1 close, expected).
We see CAG as a relatively inexpensive name (13.8x calendar 2013 EPS versus the packaged food group trading at 17.6x) that has additional upside to earnings on a standalone basis as well as a transformative acquisition that is scheduled to close during calendar Q1 2013 that should provide investors a path to a higher EPS profile through accretion and synergies. The knock on an otherwise fine quarter was the decline in volumes (-4%) as the company continues to lap pricing activity in the prior year. Volumes should improve sequentially as the bulk of the pricing activity impacted prior quarters (70% by management commentary). Further, investors should put these volume declines in perspective and compare and contrast with the “old” CAG where management would have been more concerned about chasing volume and less concerned about preserving profitability. Instead, management delivers on profitability while continuing to invest in brand building, which should reap rewards in the coming quarters.
Also, a declining input cost profile as mentioned by the company and consistent with both our sector thesis and macro view should provide income statement flexibility going forward. We see an opportunity for the stock price to move to the mid-$30s in the coming months.
Robert Campagnino
Managing Director
HEDGEYE RISK MANAGEMENT, LLC
