Don’t Slurp Your Campbell Soup

In its most recent earnings report, Campbell's Soup (NYSE: CPB) suffered a 12% profit drop but will new management revive its fortunes?

My son's high school roommate was an heir to this soup dynasty's fortune. And it may be that the need to protect such heirs is affecting the way Campbell chooses its CEOs and allocates its capital.

A new CEO, Denise Morrison, took over on August 1. And in her first quarterly report as CEO, she announced a 12% drop in Campbell's fourth-quarter profit. But taking out restructuring charges, Campbell beat adjusted analyst EPS expectations of 38 cents a share by a nickel.  Moreover, its revenue rose 6%  to $1.61 billion thanks to higher prices and growth in its international and baking and snacking segments.

To protect its heirs, Campbell appears to have recognized that soup is not as popular as it used to be -- so it's diversified. That's a good thing for shareholders because Campbell's revenue from its soups and sauces business fell 8% -- including 9% drop in soup sales even as soup profits improved thanks to higher prices and fewer promotions. And its beverage sales -- it makes V8 -- fell 1% due to tougher competition.

The good news came from a different part of Campbell -- its global baking and snacking segment increased 17% thanks to higher sales of Pepperidge Farm products, cookies, crackers and frozen products. Its international business was up 12% due to rising demand in Europe, Canada and the Asia Pacific region. And Campbell enjoyed a 10% boost in revenue from its North American foodservice business that sells to restaurants and cafeterias.

To its credit, Campbell is making the right moves when it comes to cost cutting and innovation. It's slashing 770 jobs worldwide and closing its operations in Russia and a plant in Marshall, Mich. But its also investing in a $30 million Pepperidge Farm "innovation center" to create new bakery and snack products. And Campbell will look internationally for future growth, according to AP.

It sounds like Campbell's turnaround could pay off. But should you invest in it and is now the time? Here are four reasons to consider it:

• Good earnings reports. Campbell has been able meet or beat analyst expectations fairly consistently and has done so in four of its past five earnings reports.
• Increasing sales and profits and decent balance sheet. Campbell has been increasing sales and profits -- but slowly. Its revenue has increased at a 1% annual rate from $7.4 billion (2007) to $7.7 billion (2011) while its net income has increased at a 3.5% rate from $702 million (2007) to $805 million (2011) — yielding a solid 11% net profit margin. Its long term debt has grown much more slowly than its cash. Its debt rose at a 3.4% annual rate from $2.1 billion (2007) to $2.4 billion (2011) while its cash was up at a 61.6% annual rate from $71 million (2007) to $484 million (2011).
• Good dividend yield -- Campbell pays a 3.7% yield.
• Out-earning its cost of capital -- but it's losing ground. Campbell is earning more than its cost of capital – but it’s getting worse. How so? It’s producing negative EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, Campbell's EVA momentum was -1%, based on 2010 revenue of $7.7 billion, and EVA that fell from first 2010's $663 million to 2011's $590 million, using a 6% weighted average cost of capital.

One reason against:

• High valuation. Campbell's price-to-earnings-to-growth ratio of 1.82 (where a PEG of 1.0 is considered fairly priced) means its stock price is expensive. It currently has a P/E of 12.4, and its earnings per share are expected to grow 6.8% to $2.54 in fiscal 2013.

It looks to me like it's too early to bet on a turnaround at Campbell. Campbell will only be worth buying if its stock price plunges and it meets its 2013 EPS growth target or it maintains its current P/E but grows earnings far faster than 12%. There's no hurry to invest in Campbell.