The Long and Short

A defensive play heading into a recession

| September 30, 2022

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.

With the Fed setting the stage for a recession in their battle against inflation, the North American packaged food credits are a potential defensive play. Price increases will remain a crucial component to offsetting increased costs for most inputs including raw ingredients, energy/transportation and labor. Credits that aggressively reduced debt  after the pre-Covid M&A spree, and balance price increases to preserve margins, are the best positioned. The Campbell Soup (CPB) credit not only has the lowest leverage amongst peers, but has preserved margins throughout this highly inflationary period. A positive outlook by S&P could potentially lead to an upgrade of CPB’s rating, proving a catalyst for spread tightening.

Our analysis highlights Campbell Soup (CPB) as it provides the most spread per turn of leverage in the 5-year part of the curve (Exhibit 1).

Exhibit 1. BBB North America Packaged Food Comparison

Source: Bloomberg; Company Reports; APS

A Solid Year for CPB

CPB released fourth quarter and full year results earlier this month, with full year organic net sales and earnings per share (EPS) coming in at the high end of management’s guidance range, despite the volatile economic climate.  Full-year organic sales were up 2% while EPS was flat from the year-ago period.  The soup business, which had struggled for years and prompted management to focus on the snacks business as its growth engine, has witnessed a resurgence as the consumer looks to make the dollar stretch.  CPB witnessed strong consumption growth in both wet and condensed soups of 8% and 9%, respectively, in the most recent quarter.

CPB’s LTM EBITDA margin of 19.3% grew 90 bp year-over-year and is roughly in line with CPB’s EBITDA margin of 19.6% pre-Covid.  The strength in the EBITDA margin underscores CPB’s resilient product categories that strengthen during economic challenges.  Additionally, management has been coupling both price increases and cost containment measures to retain margin.  CPB noted that they have delivered $850 million in multi-year cost savings and is on target to deliver $1 billion in savings by fiscal year 2025.

Potential Upgrade in the Future?

CPB and KHC are the only packed food credits that have a positive outlook assigned to their S&P rating.  During the height of the pandemic, S&P revised CPB’s outlook from stable to positive due to its accelerated deleveraging strategy along with improved results in the soup business. Post the Snyder’s acquisition, leverage climbed above 5.0x, but has since declined nearly 2.5 turns.  S&P noted that they now believe CPB can maintain leverage of 3.0x over the long term given the improvement in the base-line performance of the business.

Furthermore, management’s conservative financial policies help to support higher ratings.  While most packaged food peers have kept shareholder remuneration within the confines of free cash flow, CPB’s percentage of free cash flow allocated to dividends and buybacks is one of the lowest (65.8%).  Peers are largely in the 70%-90% range, with MDLZ above 100%.  Should S&P raise its rating on CPB, we note that the commercial paper rating will also be raised to A2, providing for a lower cost of short-term funding for CPB.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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