Drip
Portfolio Report
Wednesday, February 11, 1998
by Jeff Fischer
([email protected])
ALEXANDRIA, VA (Feb. 11, 1998) -- It's all about distribution and costs, my friend.
When a company sells a repeat-purchase, inexpensive item, and that company is the category killer in its market, the difference between decent returns on investment and extraordinary returns greatly resides in the distribution network -- and in the costs of filling that network. Enter, the "New Campbell."
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %> is building out its distribution in both the U.S. and in its relatively nascent international markets, while at the same time slashing costs and thereby pumping up operating margins. And, at the same time, the company is also pumping up advertising (to juice sales in its new distribution channels) and using the cash flow created, in part through cost savings, to consistently buy back shares.
In addition to all of that, the company is spinning off lower margin divisions to focus on its "Best in Show" products -- as Campbell calls them -- thereby improving the chance for higher growth in the leading products, and all but guaranteeing higher margins and cash flow.
A beautiful arrangement? You bet. Especially if the company in question already dominates its business with more of an iron grip than Coca-Cola has over PepsiCo. And Campbell does. The top-three selling consumer shelf-stable food products by dollar volume are, in order, Coca-Cola Classic, PepsiCo, and Campbell canned soup. There are no other soups on the list of the top-twenty selling shelf foods. Only Campbell. In fact, of the top-ten selling products in this category, all are beverages except for Campbell Soup.
Growth: Campbell is expected to grow earnings per share around 14% a year over the next few years, but with the spin-off of inferior businesses and an increase in advertising, more cost-cutting, and with share buybacks planned in the amount of 2% of all shares every year, the company could very well be capable of increasing earnings per share at a sustainable 15% to 17% per year, up from 13.7% over the past five years. This is a growth rate that beats the average market return by 36% to 55% annually.
Cost-Cutting: Where does the cost-cutting come from? In part, from the elimination of weaker businesses (the $1.4 billion spin-off planned for next month), but also from a reduction in production costs. After improvements in the early 1990s, the process of actually canning soup became much more efficient, leaving the industry with excess production capacity. Reductions in manufacturing costs should now continue, according to the new Campbell CEO, Dale Morrison -- of PepsiCo ties -- who is taking the reigns from David Johnson -- of Gerber ties. Of the soup production capacity existing in the U.S., about 40% to 50% is not being used, and is not currently needed. There is room to save money here.
A leading consumer company should continually learn to save money in production, and then make more money through distribution by focusing on the best-selling, highest margin products, advertising them, and getting them into every location possible.
Distribution: Campbell is building its distribution in part by focusing on non-traditional markets -- but definitely viable new markets. While supermarket sales are relatively flat, Campbell has met its annual goal of an 8% increase in domestic soup volume sales by beginning to distribute products through chains like Wal-Mart. In 1997, supermarket volume rose only 4%, but Campbell had sales gains of 130% in mass merchandising chains, 60% in drug stores, and 25% in club stores. In fact, Mr. Morrisson expects the Wal-Mart channels to approach $1 billion in soup sales for the company by the year 2000, up from the roughly $175 million achieved last year.
Advertising: Campbell recently began the largest advertising campaign in the company's history, and it plans to increase its advertising expenditures (when compared to its sales dollars) to 8% of sales -- the Coca-Cola and Gillette range -- from a recent 4.6% of sales. The advertising should be focused heavily on key, high-margin products, such as chicken noodle soup and the Pace Picante Sauce product lines.
Margins: The operating margins of the soup and sauce division were a giant 27% last year, easily topping those of Coca-Cola, and were probably above 30% most recently. Pace's margins alone are thought to run above 35% -- beating the margins that PepsiCo earns on its salty snack food division. And the best-selling condensed soup probably carries margins above 30% as well.
Product sales: The soup and sauces division accounted for 68% of sales and 80% of operating earnings last year. These divisions are happily going to increase in stature tremendously with the spin-off of other divisions, and overall margins will increase with them.
Put it all together, baby: The forces that will drive up sales volume will be increased distribution in new venues as well as increased advertising -- not to mention acquisitions that we'll touch on tomorrow. While a repurchase plan of 2% of all shares per year is icing on the cake, if the company can do it, and the estimated cash flow of some $2 billion by the turn of the century makes it all the more possible.
For Coca-Cola to buy back 2% of shares in even one year it would need to spend over $3 billion. Not going to happen. Campbell, at current prices, needs to pay only $500 million per year to buy back 2% of shares. Add the 1.5% dividend payment (compared to Coke's 0.80%) and shareholders are essentially getting a 3.5% dividend per year.
For Coca-Cola stock to appreciate 15% per year for 10 years, the market cap would need to become an astounding $606 billion. At the same rate of growth for 10 years, Campbell's market cap would become around $90 billion, still a full 40% below Coke's current market cap. Of course this is all relative to sales, but consider the price-to-sales multiple that Coke might have to sport at a $600 billion market cap. (These numbers don't include share buy-backs or dividends, both of which are in Campbell's favor.)
The contest: 2/10/98 Now Change Campbell Soup $54 11/16 $55 7/16 +1.37% Coca-Cola $67 15/16 $68 7/8 +1.38%A NECESSARY word on Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>: Today Tom Kurlak, an analyst infamous for his changing views on semiconductor stocks, voiced yet another opinion. In 1996, he thought that Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> would earn some $15 per share in 1998. Now the company is actually expected to lose money this year. Today it was said, and I quote, that Kurlack "[s]ees Intel Corp. locked in a losing battle with its customers who want lower prices."
But Intel initiates its price cuts, increased its price-cutting schedule voluntarily, and is leading in the low-end market just as it does in the middle. While the move to 0.25 technology will lower Intel's manufacturing costs even more. The more chips that you can put on a wafer, of course the less expensive they are to produce, so expect more price cuts from Intel in the years ahead, as always, as is Intel's plan from the beginning. Also, Intel has the most growth potential in the expensive high-end market, especially beginning in 1999.
I guess we should thank Kurlak for the buying opportunity if the stock is lower come March 1.
Have a Foolish evening...
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