Campbell Soup (CPB) 23Q4 Update

23Q4 Results Exceed Expectations; Agrees to Acquire Sovos Brands; Maintaining Buy Rating; Lowering PT

Campbell Soup Company (CPB) reported 23Q4 diluted EPS of $0.56 above last year’s $0.32 and my estimate of $0.34.  Non-GAAP EPS was $0.50, below last year’s $0.57, but above my estimate of $0.47.  Net sales were $2.07 billion, 4.1% above 22Q4 and in line with my estimate.

For fiscal 2024, management expects net sales growth of ‑0.5% to +1.5%, organic net sales growth of 0% to +2%, adjusted EBIT growth of +3% to +5% and adjusted EPS growth of +3% to +5% (which equates to adjusted EPS of $3.09 to $3.15).  Prior to the updated guidance, I had anticipated fiscal 2024 adjusted EPS of $3.07.  Management’s guidance does not include the potential impact of acquisitions.

In August, Campbell agreed to acquire Sovos Brands (SOVO) for $23 per share in cash or $3.0 billion.  Sovos sells Italian food products under its flagship brand, Rao’s (~70% of net sales), and also Michael Angelo’s frozen Italian entrees and sauces and noosa yogurts.  In recent years, Rao’s has expanded its portfolio beyond its popular super premium pasta sauce to dry pasta, frozen entrees, frozen pizza and other specialty items.  The acquisition is a good strategic fit, but it is expensive at an estimated 22.5 times Adjusted EBITDA.  Campbell will finance it with as much as $3 billion of new debt.  With the high price and extra interest cost, the acquisition will likely be dilutive for at least the first year.  Campbell expects to incur $90 million of one-time integration costs (70% opex, 30% capex) to achieve $50 million in annual cost savings.  Earlier this week, Campbell received a second request for information from the FTC which will delay the closing of the acquisition until mid-2024.  Management’s fiscal 2024 guidance does not include this acquisition.  However, I have incorporated it in my estimates from 23Q4 through fiscal 2025.

Accordingly, my fiscal 2024 GAAP EPS estimate is unchanged at $2.82, but I have reduced my non-GAAP estimate from $3.04 to $3.02 (below management’s guidance of $3.09-$3.15, excluding the acquisition).  For fiscal 2025, I project GAAP EPS of $2.65 and non-GAAP of $2.95.  Since my last report, Campbell’s stock has fallen 12.0%, worse than the S&P 500’s 4.7% decline, but better than peers’ 17.8% decline, due to multiple compression from higher interest rates and concerns about the impact to earnings of the unwinding of the COVID-related spending surge.  With CPB’s price decline, I am lowering my 12-month price target by $5 to $50, but maintaining my performance rating of “1” (Buy).  The revised target price represents a potential return of nearly 26%, including its 3.7% dividend yield.

The Pending Acquisition of Sovos Brands.  Campbell announced on August 7 that it had agreed to purchase Sovos Brands (NASDAQ: SOVO) for $23 per share in cash.  With 101.3 million shares outstanding as of August 4 and $482.9 million of debt outstanding as of June 30, the acquisition has an indicated cost of $2.81 billion.  There are another 3.4 million shares of restricted stock units outstanding (by my rough estimates) that could receive as much as $78 million.  The acquisition will also incur transaction costs, including professional fees and debt underwriting fees, that could amount to $50 million (as a guess).  The total cost of the acquisition, therefore, could approach $3 billion.  (However, my acquisition cost estimate does not adjust for the $169 million of cash on SOVO’s balance sheet at July 1, 2023.)

The primary attraction of Sovos Brands for Campbell is the Rao’s Homemade pasta sauce business.  Rao’s expands Campbell’s presence into the ultra-distinctive pasta sauce category, which grew at a compounded annual rate (CAGR) of 33% from 2017-2022, according to Circana.  Combined with its mainstream Prego brand, Rao’s will help Campbell in its efforts to achieve $1 billion in annual Italian sauce sales and give it the leading market position in the fastest growing Italian sauce tier.  Rao’s could therefore be to Prego what Pacific Foods has been for Campbell’s soup business.

Rao’s Homemade Italian sauce has been quite successful in recent years.  Its retail net sales grew at a 39% CAGR from 2019-2022.  That equates to a greater than 10 point market share gain (since 2019), giving it the leading market share in the ultra-distinctive category.  Campbell believes that it can continue to build upon this success by bringing its own marketing and sales execution skills and strong customer relationships to expand Rao’s retail distribution to more stores and geographies, thus eliminating “white space,” increasing store sales volume and building greater brand awareness to improve household penetration rates.  It also believes that it can improve operating margins through scale economies in commodity purchases and productivity gains.

Still, Rao’s growth has undoubtedly benefited from the shift by consumers during the pandemic to eating more meals at home.  In recent years, price increases have also raised the dollar value of sales but slowed volume growth.  As with the rest of the food products industry, these past tailwinds are turning into a headwind for sales growth, which may slow the growth trajectory of Rao’s Homemade.

Along with its pasta sauce business, Rao has also expanded it product portfolio to include super-premium ready-to-serve soup (a natural fit for Campbell’s soup business), frozen pizza, frozen Italian dinner entrees, dry pasta and specialty products.

In frozen foods, Sovos’s main brands are Michael Angelo’s and Rao’s Homemade.  Michael Angelo’s offers premium frozen Italian dinner entrees and its recently launched line of Italian sauces.  The brand’s annual revenues have been roughly flat in recent years, averaging about $81 million annually.  Rao’s Homemade is a new entrant to the space and now offers both frozen Italian entrees and pizza.  Sovos’s frozen products are produced at a single manufacturing facility in Austin, Texas.  Thus, the combination of Michael Angelo’s and Rao’s helps provide scale economies in production.

Campbell’s Pepperidge Farm business also sells frozen products, but its focus is exclusively on bakery products (i.e.  cakes, pastry shells, fruit turnovers and bread).  There may be some scale economies in distribution by combining the businesses and perhaps some scale economies by combining its commodity purchases with those of the Campbell’s Meal and Beverages segment.  If Sovos’s frozen food business is sufficiently profitable, Campbell may choose to keep it for the long haul.  If Campbell wishes to grow the frozen business over time, it probably will need to make one or more acquisitions to gain a greater market presence and operating scale.

Similarly, Rao’s is a small player in the competitive dry pasta business.  Building scale there will almost certainly require one or more acquisitions.  Campbell’s might also choose to license the Rao’s brand to a third party, sell the dry pasta business or discontinue it over time.

Campbell may face a similar decision with Sovos’s noosa yogurt business.  The yogurt business is not a fit with the rest of Campbell’s businesses, but management says that noosa is profitable; so it will have time to evaluate its strategic options for the business (i.e. to grow it or sell it).

While the Rao’s Homemade Italian sauce business is an obvious strategic fit, its integration into Campbell faces at least one potential challenge:  Sovos relies on a third-party co-packer (i.e. a contract manufacturer), La Regina di San Marzano di Antonio Romano S.p.A. of Italy, for the substantial majority of its Rao’s Homestyle sauce product line.  Most of Rao’s sauce is produced in Italy and shipped to the U.S.  La Regina has established a production location in Alma, Georgia; but all tomatoes used there are still shipped from Italy.  Sovos also rents its distribution center in Alma from La Regina.  Rao’s has the right to purchase the entire Alma facility, but the process may take time.  Since the tomatoes are sourced from Italy and Campbell’s plans to keep the arrangement with La Regina, the potential savings in purchase costs will be limited and the company will have greater exposure to currency fluctuations.  Campbell may choose to end its relationship with La Regina eventually, but that may have repercussions with consumers, if it is not able to replicate or enhance the taste of Rao’s sauces.

Along with the strategic challenges to Campbell, the acquisition of Sovos is also expensive.  According to my estimates, the roughly $3 billion purchase equates to a multiple of 22.5 times projected 2023 adjusted EBITDA of $133.3 million.  (My adjusted EBITDA estimate differs from Sovos’s in that it does not add back approximately $4.0 million of non-recurring costs.)  With estimated annual synergies of $50 million, the purchase price multiple would be reduced to 16.4 times.

The acquisition will likely be financed entirely with debt (perhaps some combination of bank debt and public bonds).  At Campbell’s current debt yields, it would come with an average interest rate of about 6%.  Incremental interest expense would therefore be about $180 million annually.  Thus, adjusted EBITDA will not be sufficient to cover interest costs until the $50 million of synergies are realized.  In addition to the $50 million of synergies, profit growth from Sovos’s businesses will be necessary to begin paying off the added debt and producing a return on Campbell’s investment.  Accordingly, Campbell says that the acquisition will not be accretive to earnings until the second year after its closing.

On October 16, SOVO shareholders approved the acquisition by Campbell.  On October 23, Campbell announced that the FTC has requested additional information in its review of the proposed acquisition, which will delay the closing until mid-calendar year 2024, during Campbell’s fiscal 2024 fourth quarter.

Despite its strategic, operational and financial challenges, the acquisition of the Rao’s Homemade Italian Sauce business appears to be a good strategic move.  Along with Sovos’s other businesses, the acquisition gives Campbell greater strategic flexibility to pursue new potential growth avenues.

This is a summary of my recent update report on Campbell Soup Company (CPB). To obtain a copy of the full report, please reach out to me using the contact information provided below.

October 30, 2023 (Report published on October 28, 2023.)

Stephen P. Percoco
Lark Research
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Linden, New Jersey 07036
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© 2015-2023 by Stephen P. Percoco, Lark Research.   All rights reserved.

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