“Cooking is in a very good place right now.” CEO of Conagra, Jan. 7.
Better inventory driving sales acceleration (STZ)
Constellation Brands reported FQ3 EPS of $3.09 ($3.16 ex. Canopy, +32% YOY) vs. consensus of $2.42. Better than expected sales and margins drove the beat.
Beer shipments catch up to demand - Beer Organic net sales grew 30%, accelerating from 1% last quarter. Beer depletion growth was 12%, up from 4.7% last quarter. 3-4% depletion growth was driven by restocking. Modelo Especial depletion grew 20%. Corona grew 12% in IRI measured channels. Pacifico grew 35% in IRI measured channels. Management said they sold all the Corona Hard Seltzer they produced. The one package produced had the second-highest velocity of all hard seltzers. Before the summer, they will launch their second SKU with capacity doubling. Beer shipments grew 28%, up from -1.6%. On-premise decreased by 35% in the quarter and 53% for the year. Beer operating margins expanded 330bps despite some added transportation costs to accelerate shipments. Marketing spend increased, but due to the high rate of sales growth, it leveraged 170bps. Shipment volume is expected to be above depletion for the remainder of the year. The Obregon expansion has encountered some delays due to the pandemic and will now be completed in early F2022. Management believes the expansion will provide the capacity over the medium term.
Wine and spirits segment reconstructed - Wine depletion volume declined 1%, reflecting brands that were just divested. Organic net sales grew 13% while shipments increased by 7%. Operating margins contracted 200bps due to a shift in spending from the first half. For F2021, the segment’s sales and operating income will decrease 9-11%, and 16-18% reflect the divestitures with the divestitures, the wine and spirits segment targets low to mid-single-digit top-line growth plus margin expansion. For F2021, the segment is targeting 2-4% revenue growth.
Margin projections increasing despite management’s best efforts - Constellation Brands recorded a $770M increase in its Canopy investment's fair value. The company ended the quarter at 3.3x leverage. The company announced an additional $2B of share repurchase authorization on top of the $1.9B remaining. Marketing expense is expected to be 9 to 9.5% of sales. Management guided the year to $9.80-$10.05. That includes lower implied margins due to increased marketing, expedited freight expense, increased expense at Obregon construction, a shift of brewery maintenance from Q3 to Q4, and a staggered price increase plan.
In half a year, the concerns over leverage, its cannabis investment, hard seltzer, brewery expansion, and the shutdown in Mexico have, for the most part, become tailwinds. Constellation Brands is a Best Idea Long.
Removing Conagra from the long bias list (CAG)
Growth decelerating - Conagra reported FQ2 EPS of $.81, beating consensus of $.74. Organic sales grew 8.1%, slightly above the high end of the 6-8% guidance. Organic sales growth decelerated from 15% in the previous quarter. Retail sales grew 10.4% (Q1 +12.9%) with snacks up 10.8% (Q1 +14.6%), frozen up 8.3% (Q1 +13.5%), and staples up 12.7% (+11.6). The snacks segment retail sales were driven by popcorn up 21.3%, sweet treats up 10.2%, meat snacks up 9.1%, and seeds down 6.3%. The staples segment was driven by 29.7% growth in Hebrew National, 25.2% growth in PAM, and 17.8% growth in Reddi-Wip (Q1 growth was driven by Armour, Wishbone Hunt’s). (Not exactly the foods you consider “cooking” when you read that Americans are preparing more meals at home.) The frozen segment was led by 15.7% growth in plant-based meat, while frozen single-serve meals grew 10.5%, frozen vegetables grew 6.6%, and multi-serve meals grew 3%. International grew 9%. International margins expanded 450bps. Foodservice volumes decreased by 25.3%. Foodservice margins contracted 340bps.
Smaller margin expansion - Gross margins gained 140bps driven by 440bps of tailwinds from productivity, price/mix, and COGS synergies. COGS inflation was a 200bps headwind, while COVID-19 costs were a 100bps headwind. In Q1 gross margins expanded 240bps with productivity tailwinds of 610bps offset by 220bps of COGS inflation. SG&A leverage was 110bps compared to 190bps in Q1. Operating margins expanded 250bps to 19.6%, above guidance for 18 – 18.5%. The company captured an additional $27M of synergies in the quarter, with total cumulative synergies now $246M.
In-line guide - Management reaffirmed guidance for the year and issued Q3 guidance of $.56-.60 bracketing consensus expectations. Organic growth is expected to be 6-8%. Management’s guidance reflects shipments in line with sell-through as grocers continue to see strong demand. Conagra has now reached its 3.6x leverage early, driven by the results during the pandemic. Pinnacle Foods' integration has not been the smoothest, so investors may not be ready for another acquisition. It may come sooner as it would offset the comparisons of the pandemic. Management was also hesitant to talk about pricing when addressing the inflationary headwinds on the horizon.
We are removing Conagra from our long bias list. The valuation is undemanding at ~13x EPS and 11x EBITDA. We do not think there is anything “wrong” with the company. Our estimates for the remainder of the year are higher than consensus. Still, we do not think investors will award the earnings a higher multiple until there is more visibility on comparisons. The shares are unlikely to have enough upside lapping the pandemic while inflationary cost headwinds mount. Our updated position monitor is below:
Full recovery, not priced in (LW)
Lamb Weston reported FQ2 EPS of $.66, $.29 lower YOY, but ahead of consensus expectations of $.63. Overall restaurant traffic in the U.S. held at ~90% of pre-pandemic levels until November due to additional restrictions placed on restaurants. Traffic at large chain restaurants was essentially at prior-year levels while full-service restaurants were at 70-80% of the prior year. Traffic at non-commercial customers like schools and lodging was at half the prior-year level. In the retail channel category, volume was up 15-20%. In Europe, traffic softened to 75-85% of the prior year during the later part of the quarter. In China and Australia, traffic was nearly at prior-year levels while Asia and Latin America improved sequentially but were down well below prior-year levels.
Sales little changed sequentially, but more margin contraction - Lamb Weston sales declined 12% with volumes down 14% in line with the previous quarter. North America and Europe shipments were down 15%.US restaurant demand were down 10%. Price/mix improved 2%. The global segment was down 12%, with volume down 11% driven by volume outside of the home internationally. International sales were down 20%. The foodservice segment declined 21%, with volumes down 25%. Independent and restaurants slowed to down 30% late in the quarter. Retail segment sales increased by 7%. Volume was up marginally. Gross margins contracted 300bps partly due to processing older potatoes. SG&A decreased $8M due to lower incentive compensation and less advertising.
Recent trends weaker - Quarter to date shipments were down 15% in the U.S., similar to the end of Q2. Other than US QSRs, demand is expected to remain soft. Management expects potato demand to decrease in the near term but to recover to pre-pandemic levels by the end of C2021. FQ3 looks to be the reverse of Q2 with weaker trends initially but improving trends later in the quarter with the vaccine rollout. The potato crop, as well as contract negotiations, were characterized as consistent with recent years.
Lamb Weston is on our long bias list. We are constructive on the company and see a full recovery by the end of C2021. We also do not see any structural changes in end demand or the competitive environment that would alter its future earnings power.
