No Holiday Cheer for Campbell Soup

As such, we believe the high-single-digit downdraft in shares is overdone and view this wide-moat stock as modestly undervalued, trading at a 10%-15% discount to our unchanged fair value estimate.

We weren’t surprised by the pronounced stepdown in profits, as we never viewed year-ago levels as sustainable. More specifically, we’ve long thought raw material inflation would re-emerge (most recently in meat, steel cans, and dairy), which in the aggregate ate into gross margins to the tune of 250 basis points in the quarter. These challenges were compounded by heightened transportation and logistics costs following recent hurricanes.

Further, the mix shift to lower-margin natural and organic fare (which represents around 10%-15% of sales) at the expense of higher-margin soup sales (which were down 9% in the quarter) also constrained profitability by around 80 basis points.

And despite the 5% reduction in marketing relative to last year, we continue to believe Campbell needs to up the ante on brand spend (in terms of value-added new products and advertising) to differentiate its fare in this competitive space. As such, we forecast marketing to tick up to 6% of sales on average over the next 10 years (versus 5% on average the past three years) and R&D to approximate 1.8% of sales (about $150 million each year, or about 40 basis points above the three-year average).

In light of these headwinds, we think Campbell’s focus on driving efficiencies (targeting $450 million in cost savings, which strikes us as achievable) is wise, but unlikely to bolster operating margins above the high teens longer term.

Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.