Campbell Soup Company – Free Cash-Flow to Equity Valuation

There are very few people left in the free world who don’t know this company or recognize its iconic food labels. It is primarily recognized for its condensed and ready-to-serve soup products, but there is far more to this company than meets the eye. Campbell Soup Co. (CPB, Financial) is the manufacturer of well recognized Swanson broth and stocks; Prego pasta sauces; Pace Mexican sauces; Campbell’s gravies, pasta, beans and dinner sauces; Swanson canned poultry; and as of June 13, 2013, Plum Organics food and snacks.

In addition to its “Simple Meals” products, it also has a broad line of baking and snacking and beverage products. Some of its most recognizable brands include: Pepperidge Farm cookies, crackers, bakery and frozen products, Arnott’s biscuits, Kelsen cookies, V8 juices and beverages and Campbell’s tomato juice.

With almost two dozen leading global food brands within its portfolio, its soup brand remains without question the most important. Global research estimates suggest that CPB holds about 60% of the global prepared soup market with three of its top soups representing three of the top food products sold in grocery stores every week in the United States. This is an incredible accomplishment. More than 75% of households in the United States are believed to purchase CPB products every week. And more than 95% of retail food chains, mass discounters, mass merchandisers, club stores, convenience stores, drug stores, dollar stores and other retail, commercial and noncommercial establishments are believed to stock at least one of CPB’s product lines. The company's five largest customers account for approximately 35% of the company's consolidated net sales. The company’s largest customer, of course, is Walmart Stores Inc. (WMT, Financial), which accounts for 19% of sales.

In total, CPB’s products are distributed in more than 120 countries. U.S.-based sales account for about 70% of total revenues, though this number has been slipping. The company’s products are manufactured in a handful of key production facilities in the U.S. and some key facilities in Australia, Europe and Asia. Core production inputs and packaging materials are sourced from various suppliers. Input costs, and hence overall company profitability, are highly cyclical and depend to a large degree on global crop sizes, cattle cycles, product scarcity, demand for raw materials, energy costs, government-sponsored agricultural programs, import and export requirements and regional drought and other weather conditions during the growing and harvesting seasons.

A few upside considerations

• CPB’s growth efforts remain focused on simple meal sales, baked goods sales, and healthy snacks and beverages which we feel are well aligned with broad market trends.
• The company continues to launch more innovative marketing, brand recognition and packaging activities, which we think will help to move its brands forward.
• The company has made multiple acquisitions over the last few years, which should help to boost its international sales.
• CPB’s brand strength is phenomenal, controlling the number 1 or number 2 positions in all markets in which it operates.
• We like the company’s focus on product innovation—it has released dozens of newly flavored soups over the last few years, a series of veggie snacks and a larger assortment of fruit juices.

A few downside considerations

• CPB’s sales growth continues to run on fumes, and the feeling is that this is not about to change any time soon.
• The size of the overall U.S. soup market has not grown in years, and CPB was late to jump into the international arena. It is unclear whether it will be able to establish the same level of dominance internationally that it achieves domestically.
• The company’s core customer base continues to age. It is unclear how successful uptake will be among younger less affluent generations.
• CPB's successful new product launches might simply work to cannabolize existing sales.

Market expectations

CPB is set to report fourth-quarter fiscal 2015 results on Sept. 3, 2015. The market expects revenues of $8.1 billion for 2015 and $8.2 billion for 2016. Earnings per share is estimated to reach $2.43 in 2015 and $2.53 for 2016. In the last quarter, the company posted a positive earnings surprise of 21.6%. No one knows with certainty whether CPB is likely to beat earnings estimates this quarter, but management has indicated that growth initiatives are advancing as planned and that recent acquisitions are being integrated effectively. The company recently upgraded its EPS guidance for fiscal 2015, based on gross margin expansion and supposed improvements in cost containment activities. The company is signaling that adjusted earnings from continuing operations will fall in the range of $2.43 to $2.46 per share, up from the previously guided range of $2.32 to $2.38. It will be interesting to see whether cost-reduction efforts are actually paying off. Factors that might move against these projections include worse-than-expected currency impacts.

Valuation

A company’s fair value estimate can be calculated as the present value of expected future free cash-flows to equity. Free cash-flows to equity represent the amount of cash-flows available to common stockholders after all operating expenses, interest and principal payments to lenders have been paid and necessary investments in capital equipment and working capital have been made to maintain and grow operations.

Here we estimate fair value in five steps:

1. We forecast the firm’s free-cash flows to equity for the next 10 years using econometric processes;
2. We discount those cash-flows to the present;
3. Calculate a terminal value for the firm 10 years out based on a long-term expected growth rate and terminal discount rate and discount it to the present;
4. Add the discounted terminal value to the discounted value of free-cash flows to equity over the next 10 years; and
5. Divide the present value of all cash-flows by the diluted number of shares outstanding.

Figure 1 presents our free-cash flow estimates. Figure 2 presents valuation results and Monte Carlo Simulation results.

Figure 1: Free cash-flow estimation

Figure 2: Fair-value estimation and Monte Carlo Simulation

Conclusion

CPB’s per share earnings in 2014 were $2.59. Historical earnings per share grew at an annual rate of approximately 4.7% per year since 2005. CPB’s sales per share in 2014 were $26.16. We project that sales will grow at a blended rate of about 3% per year between 2015 and 2024. We expect stable operating and net margins. Interest expenses will remain stable at about 1.5% of sales. Capital expenditures will remain at recent historical levels in the amount of approximately 4% of sales. Our fair value estimate of CPB equals $47.20. At a current price of $50.40, this suggests that CPB is overpriced by about 6.3%. Also, based on a pure Monte Carlo Simulation, there is a 57% probability that the company's true underlying fair value is less than the current market price.