Conagra (NYSE:CAG) is riding the novel coronavirus wave. CAG stock just hit new 52-week highs, and for very good reason.
Food companies are reporting strong results thanks to the novel coronavirus. As people stay at home, they cook more for themselves, as opposed to relying on restaurants. Investors have figured this trend out. As a result, we’ve seen a surge for grocery stores and the food companies that fill their shelves.
So, investors might reasonably assume that Conagra is just cashing in on the stay-at-home trend. If so, its recent gains might quickly disappear. However, there’s a lot more to the story than that.
A Recentering and CAG Stock
Between 2017 and the beginning of 2019, ConAgra lost half its value, as shares plummeted from a high of $42 to just $20 at the low. What went wrong? ConAgra has a collection of food brands that are somewhat well-known but are hardly superstar lines. These include Marie Callender’s, Reddi-wip, Hunt’s, Healthy Choice, Slim Jim, and Orville Redenbacher’s.
As a result, the company’s operating results stagnated in recent years. There’s only so much organic growth you can extract from these sorts of staid labels. So ConAgra decided to go on a radical makeover.
It spun out some of its stable but most boring business, such as the frozen french fries operation into a new public company called Lamb Weston (NYSE:LW).
Ironically, french fries were the place to be. Lamb Weston stock went on to crush ConAgra, its old parent. That’s in large part because ConAgra turned its attention to buying Pinnacle Foods in a $10.9 billion deal.
Pinnacle brought many more youth-focused brands to ConAgra, including labels riding popular consumer trends such as organic products, and gluten-free foods. Unfortunately, ConAgra dramatically overpaid for Pinnacle, causing the company to face a crippling debt load while post-earnings fell far short of expectations.
ConAgra Turned Around Pre-Covid
At the January 2019 lows with CAG stock around $20, the company was selling for just 9x earnings. While investors fretted about debt and mergers gone bad, there was still substantial value.
Management quickly righted the ship. It cut costs aggressively and reworked its marketing strategy. This got its organic sales back into positive territory for the first time in several years. Combine rising sales with a single-digit P/E ratio, and you have a compelling stock on your hands. ConAgra soared a quick 50% off the bottom.
Adding momentum to the turnaround, ConAgra finally started reining in its brands. For many years, ConAgra has been a serial acquirer, constantly adding more products, trademarks, and intellectual property to the company.
In 2019, the company went in reverse, selling off labels to other firms during a strong market where ConAgra achieve reasonable values for their divested properties. This, in turn, allowed ConAgra to come into 2020 with a defensible financial position.
Right Place, Right Time
Thus, ConAgra opened 2020 with a leaner cost structure, some operational momentum on the revenues side, and a strengthened balance sheet. Shares were up sharply. This was an excellent place to be as the novel coronavirus hit. ConAgra was already delivering and then it got a massive demand boost to drive further sales.
And, importantly, the balance sheet was in better shape. Sure, ConAgra still operates at 4x Debt/EBITDA, which is more than you’d like to see. But it’s down from 5x at the time of the Pinnacle deal, and by paying down debt in advance, it gave ConAgra wiggle room in March when financial markets froze up.
This allowed it to lean into the increasing stock-up-the-pantry demand rather than having to conserve cash. As a result, the company, during its last earnings report, said that it now expects to top the high end of guidance for revenues, profits, and free cash flow in 2020.
CAG Stock Verdict
In recent weeks, we’ve seen some investors start selling out of their defensive holdings in industries such as food, beer & liquor, and personal hygiene. That makes sense. As the economy reopens, the extra sales momentum in those sectors will start to fade.
However, investors shouldn’t indiscriminately dump all their food stocks. For one thing, the virus might stick around awhile. A solid defensive company like ConAgra serves as portfolio insurance in case the market and economy head downward again.
On top of that, ConAgra’s recent gains aren’t primarily tied to the coronavirus anyway. The company’s operating results now are largely the result of smart decisions that its leaders made back in 2019.
This fundamental reshaping of the business will continue paying off, regardless of what happens with the pandemic and people’s choices as it relates to eating out or cooking at home. There’s more to ConAgra’s rally than just a one-off round of panic food buying, and long-term investors will be rewarded.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned CAG stock.