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Conagra Brands should continue tightening to General Mills
admin | March 22, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Based on the solid results of both credits and the momentum behind the integration of their acquisitions coupled with a firm focus on deleveraging, there is value in Conagra relative to General Mills debt. Conagra spreads have moved tighter recently but there is room for further spread compression relative to General Mills, particularly in the long end of the curve.
General Mills (GIS – Baa2/BBB/BBB)
GIS’ fiscal 3Q sales and earnings per share (EPS) came in ahead of Street estimates. Sales of $4.2 billion beat estimates of $4.19 billion while EPS of $0.83 came in ahead of consensus of $0.69. Organic sales were up 1%, largely reflecting price increases which were partially offset by lower volumes. GIS witnessed organic growth across all geographies except Europe and Australia. In fact, Europe and Australia saw the largest volume decline, down 4%, which could not be offset by an increase of 2% in price/mix. Adjusted gross margin was up 170 bp year-over-year to 34.2% reflecting cost savings, price realization and the addition of Blue Buffalo. Adjusted operating profit margin was up 230 bp to 17.4%
Looking forward, the company expects Blue Buffalo’s results to meaningfully pick up in the fourth quarter as they double distribution and increase product assortment in the mass channel. Accelerated synergies, cost initiatives and pricing actions taken earlier this year should also benefit profit margins. Given the expected improvement in the pet segment for 4Q and year to date performance, management revised full year EPS and free cash flow conversion upwards. Adjusted EPS will now be flat to up 1% versus previous guidance of flat to down 3%. Free cash flow conversion is now expected to be at least 105% of adjusted earnings versus original guidance of 95%. Management has repaid roughly $800 million of total debt since the close of the Blue Buffalo acquisition, so that General Mills ended the quarter with estimated leverage of roughly 4.3x.
Conagra Brands (CAG – Baa3/BBB-/BBB-)
While overall sales for CAG came in a bit shy of estimates, $2.71 billion versus estimates of $2.75 billion, the company posted solid organic growth of 1.9%. Organic sales growth was driven by strong performance in frozen as well as snacks, up 4.9% and 8.2%, respectively, which more than offset declines in refrigerated and grocery, down 5.1% and 0.1%, respectively. Integration of Pinnacle is on track and management is focused on addressing executional challenges at Pinnacle’s top three brands: Birds Eye, Duncan Hines and Wish-Bone. Management remains confident that they can exceed their $215 million cost synergy target by fiscal 2022, as achieved cost synergies are pacing ahead of expectations. CAG had targeted $20 million of cost synergies in fiscal 2019 and now expects to come in above that level.
CAG completed the sale of the Wesson business during the quarter, and updated full year guidance to reflect the sale. Organic net sales guidance went from a range of 1%-2%, to approximately 1%. Management noted that the updated organic sales guidance removes Wesson for the entire year, not just for the last quarter. CAG remains committed to a solid investment grade rating and has repaid $685 million of debt since the close of the Pinnacle acquisition. The leverage estimate stands at 4.9x currently. Management is still targeting leverage of 3.5x and expects to achieve that target by fiscal year end 2021. CAG has been paying down its term loans and has reduced the balance from $1.3 billion to $600 million.
Relative Value
Based on the solid results of both credits and the momentum behind the integration of their acquisitions coupled with a firm focus on deleveraging, there is value in CAG relative to GIS. CAG had a significant move tighter yesterday (roughly 15-20 bp) but there is room for further spread compression relative to GIS. Currently the curve between CAG and GIS is steepest in the 30-year bonds, with a trading differential of nearly 70 bp. In the 10-year part of the curve, the trading differential is roughly 56 bp. CAG spreads could tighten another 10-15 bp based on expectations for better growth in fiscal 2020 and further deleveraging.
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