The Long and Short

Higher prices keep Campbells out of the soup

| December 8, 2023

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.

While Campbell Soup’s (CPB: Baa2/BBB-/BBB(*-)) fiscal first quarter results lined up with management expectations, the volume trend is becoming more bleak. Falling sales volume more than offset growth in net prices, which translated to a 2% decrease in net sales. Cost savings since the Snyder’s-Lance acquisition remain on track but have not been able to fully offset higher cost inflation and other increased supply chain costs. Management still remains optimistic and reaffirmed guidance for the year. But spreads on Campbell’s debt should widen and end up closer to packaged food peers.

Management now anticipates to close its acquisition of Sovos Brands by mid-2024, which means that the company will look to tap the market for roughly $2.3 billion to finance the acquisition sometime next year. The acquisition is anticipated to increase net leverage to the 4.0x area which prompted a downgrade by S&P on the announcement and Fitch to place the ratings under review for a downgrade. Given the new ratings profile and the negative volume trends, spreads are likely to widen ahead of a deal announcement. Fair value is probably closer to J.M Smucker (SJM: Baa2/BBB) with a new deal likely coming with concessions that are similar to trading levels of Conagra Brands (CAG: Baa3/BBB-/BBB-).

Exhibit 1. CPB Curve Relative to SJM and CAG

Source: Bloomberg TRACE; Santander US Capital Markets

Fiscal first quarter results

Net sales of $2.52 billion were in line with consensus estimates while EPS of $0.91 beat expectations by three pennies. Net sales declined 2% year-over-year, down 1% on an organic basis, as volume fell 5%, more than offsetting a 2% increase in pricing. The adjusted gross margin declined 10 bp to 32.1%, as cost savings measures were not able to fully offset higher inflation and increased supply chain costs. Adjusted EBIT fell 9% to $407 million, largely reflecting increased marketing and selling expenses, which were up 10% from the year-ago period. Management continues to remain focused on its cost savings program which has produced $895 million of savings since the close of the Snyder’s-Lance acquisition and remains on track to deliver $1.0 billion of cost savings by the end of fiscal 2025.

Broken down by business unit, the Snacks business continues to outperform Meals and Beverages as the unit realized a 5% increase in pricing somewhat offset by a 4% volume, translating to 1% organic growth. On a two-year CAGR basis, Snacks reported organic net sales growth of 7%. Meals and Beverages witnessed an organic sales decline of 3%, reflecting a 6% drop in volume offset by roughly a 2% increase in prices. Pricing continues to be met with volume declines suggesting that the consumer is having trouble digesting further price increases. Management noted that operating earnings for the unit fell nearly 13% driven by higher cost inflation.

Fiscal 2024 guidance reaffirmed

Management reaffirmed its fiscal 2024 guidance which was provided on its last earnings call. CPB expects net sales for the fiscal year to be in the -0.5% to 1.5% range, while organic sales should be flat to up 2%. Adjusted EPS should be up in the 3%-5% range from the $3.00 posted in fiscal 2023, translating to an EPS range of $3.09-$3.15. Adjusted EPS is also expected to be up 3%-5% for the year, in the range of $1.41 billion-$1.46 billion. Management noted that the pending acquisition of Sovos Brands is not included in the current guidance.  Once the transaction closes, CPB will update guidance for the combined business.

Agencies opine after the Sovos announcement

Moody’s affirmed its Baa2 rating but changed its outlook from positive to stable. The outlook revision reflects the higher debt and increase in leverage to just over 4.0x. While leverage will be weak for the rating, Moody’s notes that it anticipates leverage will fall to a more appropriate level for the rating within 12-24 months post close, as debt reduction and synergy realization are expected to be prioritized. Furthermore, Moody’s noted that the acquisition provides for scale and diversity while helping to fill a void in the fast-growing premium meal space, while helping to diversify away from the mature soup business.

S&P downgraded CPB by one notch, to BBB-, noting that the leverage would remain above the 3.0x trigger for too long post close. Leverage is anticipated to increase to 4.0.x and only decline to the 3.0x area for roughly two to three years post close. While management is expected to prioritize debt reduction over share buybacks, CPB is still expected to conduct anti-dilutive repurchases. The agency believes the addition of Sovos, which houses the Rao’s brand, will benefit the company’s portfolio as it adds a premium asset with high growth rates, that will help to stabilize any fluctuations in the Meals and Beverages unit. Integration risk is anticipated to be low given that Rao’s manufacturing is outsourced. Cost synergies are expected to be roughly $50 million and anticipated to be realized by fiscal 2026.

Fitch placed CPB’s BBB rating on watch negative based on the potential for leverage to too be sustained above its threshold for the current mid BBB rating. The agency noted that should CPB return leverage to under 3.5x within 12 to 24 months post the close of the transaction, they could affirm the current rating. Any rating downgrade would be limited to one notch. Fitch noted that the watch listing may take over six months to resolve.

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

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