Campbell Soup Bear's Den
by Louis Corrigan ([email protected])

Soup may be good food, but frankly, I've never liked the stuff. I think it goes back to some early childhood trauma connected to Campbell's Tomato soup. Now, I'll happily feed on hot and sour soup at my favorite Thai place, and I'll occasionally throw down some lentil or broccoli soup with a sandwich at a restaurant on a cold day. But Campbell gets zero of my limited soup budget. That means that outside a random purchase of a jar of Prego spaghetti sauce, most of Campbell's business can be summed up for me as simply the aisle at the grocery store I don't bother to go down.

Okay, I'm not an idiot. I know that Campbell dominates the U.S. soup market, with something like a 75% market share. I know the company has modest pricing power, which I agree is a big deal in this disinflationary world. Heck, I know my mom loves the "Simply Home" stuff that comes in the glass jars. (Of course, she also loves canned tuna fish, so that's not much of an endorsement.)

Because of Jeff's great work on the Drip Port and his conference call transcripts, I know a whole lot more, too. Yes, Campbell has undergone a few years of restructuring and asset shuffling that makes its financial statements a bit challenging but that's generally gone awfully well. It has ditched some mediocre businesses and acquired some strategic assets, especially soup companies in Europe. It's now focused on a bunch of leading brands, including Pepperidge Farm with its Milano cookies and Goldfish snack-thingies, Godiva with its scrumptious chocolates, Pace with its spicy picante sauce, V8 with its I couldahada V8 Splash, and so on.

Gross margins are up, operating margins are up, net margins are up, the dividend is up, the share count is down, and cash from operations is up. Campbell's has also sold off its canning operations in exchange for long-term contracts, a bit like Coca-Cola did with its bottlers. So, yes, Campbell's has done a lot right lately. It's definitely a stronger business than it was just a few years ago.

Then again, an unemotional investor -- say, a soup unenthusiast like myself who could gladly tell the Soup Nazi to get lost -- has to face some unpleasant facts.

First, two-thirds of Campbell's business comes from soup and sauces and this segment is also by far its most profitable, with operating margins of 25%. That would be great news except that sales in this division aren't growing much. Revenues were up 8% in FY98 before the impact of currency changes, but they were up just 6.3% in actual dollars, and only 4.6% in the latest quarter.

Since I know Jeff is fond of comparing Campbell with Coca-Cola, perhaps we should focus on Coke's preferred metric -- volume growth. U.S. wet soup sales rose 6% last year, but most of that was product mix and price because soup volume increased a measly 1%, in line with general U.S. soup consumption. (Coke, by contrast, has delivered 6% unit case volume growth in a U.S. soft drink market growing by just 1% annually.)

Granted, Campbell's worldwide volume growth was 4%, but big deal! Coke's unit volume growth internationally is about twice that. Plus, Campbell's has already jacked up prices for several years running. You just can't count on price increases year after year. Besides, the company's strong move into Wal-Mart stores might even reverse the price trend.

Second, part of the growth problem in the U.S. is that we Americans now spend half our food budget on edibles made and munched away from home (remember me!). Canned soup doesn't fit so easily into that lifestyle (curiously, my mom is one of the most laughingly sedentary people in America).

As a marketing guy, CEO Dale Morrison's solution is to boost ad spending (to 8% of revenues) and go after those moving food dollars by introducing microwaveable soups and expanding distribution to quick-service restaurants (say, Long John Silvers or the food court at Target), convenience stores, university dining halls, and freestanding kiosks. This brand-oriented soup anywhere/anytime campaign seems right, but it's going to be an expensive and perhaps distracting initiative that will take Campbell into retailing. Though the company operates Godiva stores, retailing isn't really a core competency.

Moreover, Campbell's fast growing soup markets are rapidly becoming more "American" in their eat-on-the-run mentality. And going back to the Coke comparison, a soft drink is just a lot easier to buy and consume on the move than soup.

Third, even though Campbell's stock is well off it high, it's more than priced in whatever growth the company can ladle out. CEO Morrison has already forecast a weaker first half of FY99 than originally projected, though he expects Campbell to make up the difference in the second half. Zacks shows current consensus earnings estimates of $2.15 for FY99 and $2.41 for FY00, suggesting 13% annual EPS growth going forward.

Yet at $52 a share, Campbell trades at 27 times trailing 12-month earnings and 24 times the current year's earnings projection. Its YPEG fair value now is just $31. With its estimates being trimmed as we enter the weak first half of Campbell's year, and shares of other brand-name multinationals like Coke and Gillette getting pummeled, its easy to imagine the stock heading closer to that YPEG value, though not all the way. For comparison, Campbell traded at just 16 times trailing earnings three years ago, before the bull market sent large caps soaring.

The facts are that Campbell is a great but slow-growing business that's priced at something of a premium. While its annual earnings per share have increased just 36% total over the last three years, its stock has soared 117% over this same period. Now, perhaps it's not crazy for a leading, brand-name, repeat-purchase food products concern with 14% net margins to trade at a PEG of 2.0 or with an enterprise value to sales ratio of 3.8. Campbell's may be a relatively safe place to put your money if you have a very long-term horizon. And if you're a sedentary soup-sipper, you'll no doubt enjoy special dividends (say, the cream of celery).

Still, I don't think Campbell qualifies as an mmm mmm good buy at the current price. If it did, Warren Buffett would have used part of Berkshire Hathaway's $9 billion in cash to buy some.

Next: The Bull Responds