Shares of ConAgra Foods (CAG) spiked after the company announced it would divest its private label brands business. However, the plan isn't a surprise since activist investors have been rattling the cage and the new CEO would like to make his mark early on. This seems like the perfect time to take profits.
After being in office for less than four months, CEO Sean Connolly has moved swiftly to turn around ConAgra's lagging private label business. Connolly is likely to replicate the plan he put in place when he ran Hillshire Brands. Connolly is looking to cut costs, invest in new brands and trim underperformers. While the plan hasn't been totally outlined, it's pretty clear Connolly will do most of what the activist investors want.
The private label business -- where ConAgra manufactures products under another company's brand -- is a mess; growth has stalled out and margins have been squeezed. In fiscal year 2015 (ended May 31), private label revenue was down 3.1%, to $4 billion. The division lost $1.4 billion. Analysts estimate the private label business earns an adjusted EBITDA of about $350 million.
Packaged food companies typically sell for 7x to 8x EBITDA, so the private label business is probably worth $2.4 billion to $2.8 billion -- or less than half what the company paid a little more that three years ago.
Who wants to fool with "center of the store" packaged foods anyway? ConAgra is plagued with a portfolio of second- and third-tier brands that have little pricing power. The business is intensively competitive. Margins are always under pressure.
ConAgra bought Ralcorp (once called Ralston Purina) in 2013 for $5 billion and acquired over 9,000 employees in the process. Analysts believe the company could try to sell the division to TreeHouse Foods (THS), Pinnacle Foods (PF) or maybe even B&G Foods (BGS). All three companies specialize in buying unloved packaged brands and turning them around. For example, Pinnacle revitalized Birds Eye frozen foods. With new products and a new advertising approach, Birds Eye has grown at a compound annual growth rate (CAGR) of 11.5% over the last five years. Pinnacle could potentially do the same for the Ralcorp brands.
Whoever buys the division will have a lot of work to do, though. It's clear ConAgra won't be able to get much for the business and further stock appreciation is limited. I've seen price targets as high as $58 on CAG. To get to $58 you have to do all kinds of tortured analysis and a lot of praying. You have to hope that Connolly can dump Ralcorp, dramatically cuts costs and restarts a whole host of tired brands. And, like he did with Hillshire Foods, sell the company to a larger company.
Who wants to wait around for that? I'd take the money any run.