I wrote in an earlier note that a short position in CPB would make me uneasy given some of the characteristics it shares with HNZ. In this note, I take a look at the reasons why CPB’s operating performance doesn’t warrant the recent move up in the company’s share price.
Since December 31st, CPB’s share price has gone from $34.89 to $39.40 (as of Friday’s close), a year to date performance of nearly 13% versus the S&P’s YTD performance of 6.6%. Admittedly, CPB has been a multi-year laggard, and so the company’s ability to exceed consensus estimates in the most recently reported two quarters has helped the share price performance, as has the HNZ deal. However, chasing laggards solely because they have lagged doesn’t represent a compelling long-term investment process to me – I need to start seeing some improvement in the company’s business momentum.
I attribute the better than consensus results to the sell-side’s inability to model in conjunction with CPB’s acquisition of Bolthouse Farms, which has muddied the income statement a bit. Keep in mind that buying a staples company that is in the process of integrating an acquisition usually isn’t a bad idea, in my experience. The sell-side is generally crappy at modeling to begin with, and the top line becomes optically much more attractive, and the company has some income statement flexibility as the merger synergies start to flow through – to be honest, it’s a part of the reason I like CAG, STZ, K and BUD. But it can’t be the only reason.
While reported revenue growth has been close to double-digits (against declines in the comparable quarters of 1H 2012), constant currency organic growth has been +1.1% and +1.5% in the first two quarters of 1H ’13, again against declines in 1H ’12. The comps turn positive in 2H ’12, though the next two quarters are less seasonally important than the two reported thus far. Keep in mind that my view is that the primary driver of multiple expansion/contraction in consumer staples is changes in top line momentum – it doesn’t appear to me that CPB has reached that type of inflection point with regard to its core business.
Importantly, EBIT growth (absent the acquisition) was only +1% in the quarter, and this result was flattered by a 14% decline in advertising and consumer promotion expense – never a good sign, in my view. Even with the acquisition, the company posted only a 7.6% year over year increase in EPS, against a -10.1% comparable in Q2 2012 – and that is with some help from a lower tax rate year on year. The EPS comps as we move through the remaining two quarters of the company’s fiscal 2013 don’t stiffen all that much.
Taking all that together, I don’t see a path to an EPS miss as consensus currently contemplates the pacing of the remaining two quarters, and that is central to wanting to be short a name. As we move out closer to calendar ’14, with the HNZ transaction in the rear-view mirror and CPB moving toward more difficult comparisons, I think a short position might make more sense, but I reserve the right to change my mind in either direction or any time should the data suggest.
While I don’t do shorts purely on valuation, it appears to us that a nearly 2 turn improvement in CPB’s P/E multiple (currently 15.0x calendar 2013) to close the gap with the peer average isn’t based on the underlying strength of the company’s business – neither is it a particularly demanding multiple. Further, I think consensus is secure for the balance of fiscal 2013 and am therefore content to watch and wait.
Call with questions.
Rob
Robert Campagnino
Managing Director
HEDGEYE RISK MANAGEMENT, LLC
Matt Hedrick
Senior Analyst
