Campbell Soup Company (NYSE:CPB) this evening announced an agreement to buy the organic foods company Pacific Foods for $700M, or 3.2x its trailing $218M in sales. Credit Suisse likes the fact that Campbell has shifted its M&A attention toward an organic shelf stable category where it has significant expertise and can add value rather than the “packaged fresh” category where it has suffered so many integration missteps and supply chain problems. However, with a price tag that exceeds 20x EBITDA for such a low operating margin business (probably single-digit), the acquisition won't provide much in the way of financial benefits nor much help for the stock. For example, management is guiding investors to expect zero accretion to EPS in the first 12 months before synergies. Even if the firm assumes synergies worth 7% of sales over time, EPS accretion would only reach $0.03/share. Credit Suisse is lowering its target price to $50/share to reflect lower valuation multiples across the packaged foods space. Rising price pressure from struggling grocer customers represents the biggest risk of further downside to Credit Suisse's target price.
This company has done a great job over the years of building a strong premium-priced soup business (90% of sales). Its convenient aseptic packaging and its purpose-driven positioning built a strong following with younger consumers, which Campbell needs to attract. The firm estimates that half of the sales come from traditional Nielsen-measured channels and half from natural foods stores. In traditional channels, the firm's Nielsen data indicates a 10% growth rate for Pacific’s soup business and a 2.7% share of the category. In contrast, Campbell’s soup business declined 1% over that timeframe and the category declined 1.5% as the major players pulled back on advertising, promotional support, and innovation.
By moving faster to integrate Pacific's operations, Campbell hopes to avoid the missteps that plagued its prior acquisitions. This included crop failures and product recalls at Bolthouse, product recalls at Plum Organics, and competitive pressure in hummus for Garden Fresh Gourmet. Pacific will fold into the Americas Simple Meals division under Mark Alexander and Campbell will provide immediate engineering, logistics, and back office support to reduce costs. Administrative cuts probably will come over time as well. Credit Suisse was a bit surprised to see that the transaction includes a supply agreement with the co-founder, Chuck Eggert’s family farms. The two parties probably designed this agreement to assure customers and consumers that Campbell will maintain the high-quality ingredients and the mission of the brand. However, in reality, Big Food companies operate better when they have flexibility in their supplier agreements to react to product shortages or price changes.
According to Credit Suisse's Nielsen data, this transaction would increase Campbell’s share of the broth category to 47% from 40% and its share of total canned soup to 60% from 57%. This might raise some eyebrows at the FTC, especially if it chooses to treat the broth category as distinct, and extend the review period beyond the normal 30 days. The break-up fee is $50 million.
The firm's $50/share target price for Campbell represents a 15.5x forward P/E on its 2018 EPS and a valuation discount of 15% to food peers compared to 8% historically. The firm believes a bigger discount is justified by the structural challenges in the company's canned soup and beverage categories and the challenges the company has faced in its efforts to expand into packaged fresh and organic foods