I’ve been following the Consumer Staples sector for quite a while, since it is perhaps the most undervalued sector in the market right now. It has underperformed the market year to date, having declined about 10% for the year (based on the price movement of XLP, the Select SPDR Consumer Staples ETF), and almost 12% since it peaked in late January of this year. Consumer Staples is also a segment of the market that tends to hold up well when the health of the broader economy comes into question, and so for a lot of investors is useful as a defensive alternative. This morning one of the most interesting headlines of the day came from two major players in the Food Processing industry, as ConAgra Brands, Inc. (CAG) has agreed to acquire Pinnacle Foods, Inc. (PF) in a deal that is valued at around $10.9 billion.
While definitely noteworthy, the move isn’t all that surprising. Consolidation has been a common theme across several industries for more than a year, and in the case of the these two companies, can certainly be seen as a necessary move for two very well-established, but by some accounts stale big companies who have both had difficulty in increasing sales as they are pressured by smaller companies that offer products that are perceived (especially among the growing Millennial demographic) as being healthier than older, more traditional brands. One of the ways a lot of larger companies are improving their results is through consolidation, where costs can be saved by merging manufacturing and other expensive operations.
While the boards of both companies have approved the deal, it still needs Pinnacle shareholder to move forward. In a joint statement, the companies said they expected the deal to close by the end of the year. PF shareholders will received $43.11 per share in cash and .6494 shares of CAG stock for each share owned of PF. CAG will also assume PF’s outstanding debt. Once completed, PF shareholders will own approximately 16% of the combined company.
What does this mean for shareholders? Until the deal closes, PF shareholders will continue to receive their quarterly dividend at a rate of $1.30 annually. CAG currently pays a dividend of $0.85 per share on an annual basis and has indicated they will maintain that payout through 2019, which means that PF shareholders will see their dividend payments shrink after the deal has closed. It is expected that the combined company will begin increasing their dividend payout on a modest basis after 2019 as they pay down the extra debt that will be coming in from the transaction. CAG has secured $9 billion in bridge financing to facilitate the deal. It is expected the $10.9 purchase price will be financed by $7.3 billion in debt, $3.0 billion of CAG shares issued to PF shareholders and approximately $600 million of additional cash. The $10.9 total price includes approximately $2.7 billion (as of PF’s latest quarterly report) of Pinnacle’s long-term debt.
The resulting company is a single larger organization with an (assumed) combined market capitalization of more than $24 billion. If the company names don’t grab your attention some of the brands that will now exist under a single umbrella might. ConAgra brands include well-known names like Blue Bonnet, Chef Boyardee, Jiffy Pop, Wesson, Alexia and Manwich, and frozen food brands like Banquet and Marie Callendar’s. Pinnacle brands include Udi’s, Glutino, Smart Balance, Duncan Hines, Nalley and Mrs. Butterworth’s, along with frozen brands like Hungry Man, Bird’s Eye and Van de Kamp’s. The frozen segments of each company’s business have been attributed as catalysts, as frozen foods in general have seen a rebound this year after years of disappointing results.
Here’s a look at a few additional numbers for each company that are of interest.
- Free Cash Flow: For the last twelve months, CAG reported $920 million in Free Cash Flow, while PF reported about $375 million. The combined total of almost $1.3 billion, against about $10.5 billion of total long-term debt after the deal closes, suggests that the new company will be very highly leveraged; but since both companies have operating profits that are more than adequate to service their debts individually, the combination should have no problem doing the same.
- Return on Equity/Return on Assets: CAG has excellent numbers in this area, with ROE of 21.08 and ROA of 7.96. PF’s numbers are also generally solid, with ROE of 14.39 and ROA of 4.83. These numbers are reflective of a conservative, consistent approach taken by management to maximize their business operations.
- Price/Book Ratios: CAG has a Book Value of $9.51, while PF’s Book Value is $20.23 per share. At the current prices of both stocks, that puts their Price/Book ratios above 3, which higher than the industry average but in line with the S&P 500 average right now. It is true that for the time being, neither company is likely to be considered undervalued; on the other hand, the acquisition of PF as announced appears to be set at what the market already considers to be a fair value for that company. That is a bit unique, since the company that initiates the acquisition is usually required to pay a premium for the other business; consider, for example the bidding war taking place right now between Comcast and Disney for many of the film production, distribution, and TV broadcast rights of 21st Century Fox.
Will the new ConAgra Brands – with a broader and larger portfolio – be more successful than both companies were separately? That remains to be seen; but either way the deal is another interesting domino in the ever-changing Consumer Staples landscape.