THE HEDGEYE EDGE
We see CAG as a relatively inexpensive name (16.5x calendar 2013 EPS versus the large cap packaged food group trading at 17.8x). We believe that CAG had additional upside to earnings on a standalone basis and is now in the process of layering in a transformative acquisition that recently closed in Q1 2013 that should provide investors a path to a higher EPS profile through accretion and synergies. The combination of synergies, accretion and deleveraging should provide a clear path to EPS growth over the next 1-2 years.
CAG recently closed the acquisition of RAH for $90 per share in cash. The transaction transforms CAG into the largest private label food manufacturer in North America. Private label grows faster (about 2x the growth of branded in the United States over the past decade), but is much more volatile in terms of top line trends and margins. RAH competes in a number of center of the store categories – cereal, pasta, snacks, sauces, etc.
Finally, as commodities continue to decline, both the branded and private label business at CAG should see gross margin tailwinds at a rate disproportionate to the balance of the staples group.
INTERMEDIATE TERM (the next 3 months or more)
The combined entity will have $18.2 billion in revenue, and should be able to grow top line in the 3-5% range, including 1 pt. from private label acquisitions. We estimate that the transaction could be between $0.15 - $0.20 accretive, conservatively and, as mentioned, above we saw upside to consensus prior to the deal with RAH.
LONG-TERM (the next 3 years or less)
Merger synergies alone could provide 4% EPS growth. We estimate that deleveraging could provide another 1 to 1.5 pts to EPS growth. Bottom line, the combined business could deliver 8-10% EPS growth without the benefit of any margin expansion associated with a more benign commodity cost environment.