Commodity cost inflation, the need for brand reinvestment, and a shifting business mix mute the wide-moat firm's margin potential.
Erin Lash, CFA
11:37 AM | Email Article
reported a dreary end to its fiscal year, as organic sales slipped 1%, adjusted gross margins fell 90 basis points to 36.1%, and adjusted operating margins edged down 30 basis points to 15% in the fourth quarter. A portion of the weakness reflected executional missteps in the Campbell Fresh business (13% of sales, down 12% in the quarter). However, we believe Campbell’s challenges extend beyond its lagging top line. We continue to think Campbell’s prospects for further margin gains could be inhibited by a number of headwinds, such as commodity cost inflation, the need for brand reinvestment, and a shifting business mix. In light of these pressures, we maintain a more muted outlook for the firm's margin potential than the market does; we expect Campbell to generate high teens operating margins over our 10-year forecast, about 200 basis points above the 16%-17% five-year average.
Erin Lash, CFA, is a director of consumer sector equity research for Morningstar.
Campbell remains a valued partner for retailers, in our opinion, given its position as a leading packaged food firm with vast resources, supporting the intangible asset source of its wide moat. But we think its competitive position is eroding as center-of-the-store grocery categories (like soup, which the firm dominates with nearly 60% share) have been losing out as consumers shop the perimeter of the store in search of healthier fare. Even though we think its focus on more impactful innovation (instead of its prior strategy that centered on bringing an abundance of new fare to market) should enable Campbell to increase sales, we don't expect top-line gains will reach the historical mid-single-digit rate; we forecast low-single-digit growth longer term.
We intend to review our near-term assumptions, but we don't foresee a major change to our $50 fair value estimate beyond the time value of money. Despite their mid-single-digit decline, the shares still trade north of our valuation, and we suggest investors await a more attractive entry point.
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