2020 packaged foods preview - credit suisse

2020 Packaged Foods Preview Big Food Looks Fresher for the Year Ahead; Recommending a Selective Approach

Packaged Foods | Sector Review

We are shifting our view on the food sector to a more neutral stance for 2020 because two of

the main drivers of our negative thesis for the past three years have eased off: 1) Profit margins

and sales growth are now in positive territory after a relatively effective cycle of reinvestment

spending; and 2) big grocery chain customers like Kroger and Walmart are becoming less

aggressive on pricing and taking a more constructive stance toward their food vendors. This is a

much better situation than a couple of years ago when the retailers were demanding bigger

price discounts, threatening them with private label, and charging new fees for inventory

handling and late deliveries. As a result, we think investors can take a selective approach to

food names in 2020 without worrying too much about a thematic pullback across the group.

Mondelez and Kellogg well-positioned for margin expansion; Kraft Heinz, Smucker,

and B&G need to reset lower. Food companies have reacted to the dynamic operating

environment by investing in e-commerce and digital marketing, reshaping the mix of their

portfolios, and adjusting their supply chain footprints. From our perspective, Smucker, Kraft

Heinz, and B&G Foods still need another year of investment to return to a path of sustainable

organic growth. In contrast, Kellogg and Mondelez appear to have invested sufficiently and are

now growing at a strong enough pace to generate operating leverage in the year ahead.

Still cautious on General Mills, Conagra, and Campbell. All three of these companies are

in a better position than they were a couple of years ago, but we do not find their risk/reward

compelling. Conagra’s distribution trends are better than we expected, but we harbor doubts

about the quality of the portfolio. General Mills has stabilized its U.S. Retail business, but the

risk of a consumer backlash against grain-free pet food formulations keeps us on the sidelines.

Campbell is reinvesting in the soup category, but we question whether it will be sufficient to

generate sustainable topline growth for the portfolio.

Things look OK for now, but structural challenges remain in place. Consumer distrust of

big food brands, declining barriers to entry, and the loss of negotiating power to big retailer

customers make this a very tepid growth sector (maybe 1-2%) without much room for error. To

succeed, these companies will need to stabilize the weak categories in their portfolios (like

cereal, canned soup, and yogurt) and leverage new technologies to improve the ROI on their

spending. Unexpected pricing pressure from customers and category-specific competitive

intensity represents the biggest downside threat to our estimates.

Outperform. Mondelez, Tyson Foods, Kellogg (upgraded in a separate report), Nomad

Underperform. Kraft Heinz, Campbell, Smucker, B&G Foods

7 January 2020

Equity Research

Americas | United States

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS,

LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business

with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Research Analysts

Robert Moskow

212 538 3095

[email protected]

Matthew Parker

212 325 4320

[email protected]

Jacob Nivasch

212 325 5219

[email protected]

7 January 2020

2020 Packaged Foods Preview 2

Table of Contents

Background 3

A Less Treacherous Set-up for 2020 .............................................................................. 5

Structural Challenges Remain In Place .......................................................................... 13

2019 Review and 2020 Outlook 25

Valuation 33

Top Picks for 2020 37

Most Upside Potential .................................................................................................. 37

Most Downside Risk .................................................................................................... 37

Large-Cap Food Bull and Bear Cases 39

Campbell (Underperform Rating, $43 Target Price) ........................................................ 39

Conagra Brands (Neutral Rating, $32 Target Price) ....................................................... 41

General Mills (Neutral Rating, $56 Target Price) ............................................................ 46

Hershey (Neutral Rating, $155 Target Price) ................................................................. 48

Hormel (Neutral Rating, $38 Target Price)..................................................................... 53

Kellogg (Outperform Rating, $78 Target Price) .............................................................. 56

Kraft Heinz (Underperform, $27 Target Price) ............................................................... 61

McCormick (Neutral Rating, $160 Target Price) ............................................................. 67

Mondelez (Outperform Rating, $60 Target Price) ........................................................... 72

Bear Case ................................................................................................................... 73

Nomad Foods (Outperform Rating, $26 Target Price) .................................................... 73

J.M. Smucker (Underperform Rating, $95 Target Price) ................................................. 75

Tyson Foods (Outperform Rating, $98 Target Price) ...................................................... 78

Appendix 81

7 January 2020


Background

Figure 1: Our View of Structural and Cyclical Challenges for Our Packaged Food Group

Source: Credit Suisse estimates

The top 20 food and beverage companies have lost share very year since 2011, mostly to

contemporary start-up brands such as KIND, Chobani, SkinnyPop, and Beyond Burger.

Consumer preferences have shifted toward organic and “real food” options with simpler

ingredients. A large percentage of “Real Food” advocates are Millennials who intrinsically

distrust mainstream legacy brands with mysterious ingredients.

Figure 2: The Top 20 Packaged Food and Beverage Companies Have Lost almost 500 bps of Market Share over the Past Eight

Years, Largely at the Expense of Niche, Entrepreneurial Brands and Private Label

Source: Nielsen xAOC plus C. Data as of 11/2019. We maintain the same 20 companies since 2011 for the purpose of this analysis and combine Conagra and Pinnacle.

Whole Foods essentially introduced organic foods to consumers on a broader scale and

educated them about how it sources its food. The major grocery chains took organic to the next

level by expanding their organic offerings to a point where they now sell more organic foods

than Whole Foods does. The big food companies tried to adapt to this trend by reformulating

their legacy brands with fewer artificial ingredients, but they found it difficult to change

preconceived notions about what their brands stand for. Organic Kraft cheese, for example,

sounds like a contradiction in terms.

Structural Cyclical

- Millennials' growing distrust of legacy brands and

processed foods

- Brand investment deprivation due to heavy cost-

cutting

- Lower barriers to entry for start-ups and new

brands

- Loss of negotiating power to big retailer customers

- Declining scale advantage with the fragmentation

of media and new channels

- Private label growth and the expansion of hard

discounters (Aldi / Lidl)

- E-commerce creates infinite shelf for consumers to

discover new choices

- Higher trade allowances to major retailers to fund

retailer price investments

- Supply chain inflationary pressures from rising

freight costs and raw material prices

- Dilutive M&A activity and integration risk from non-

core categories

47.6%

43.8%43.3%

42.8%

40.0%

41.0%

42.0%

43.0%

44.0%

45.0%

46.0%

47.0%

48.0%

2011 2017 2018 2019

Top 20

18.1%

19.2%

19.6%19.8%

17.0%

17.5%

18.0%

18.5%

19.0%

19.5%

20.0%

2011 2017 2018 2019

Private Label

34.4%

37.0% 37.1%37.4%

32.5%33.0%33.5%34.0%34.5%35.0%35.5%36.0%36.5%37.0%37.5%38.0%

2011 2017 2018 2019

Middle Tier

7 January 2020


Figure 3: Organic Food Now Constitutes Roughly 6% of Total U.S. Food Sales and

Has Grown at a CAGR of Roughly 10% Since 2007

Source: Company data, Credit Suisse estimates

Rather than investing in high growth, high risk projects to defend their turf, the food companies

spent about two years (2015-2017) employing aggressive cost-cutting methods to try to create

shareholder value. Most of them felt pressured to follow the lead of private equity-led Kraft

Heinz, which boosted its margins by 800 bps practically overnight by slashing headcount,

instituting Zero Based Budgeting programs, and consolidating its supply chain footprint. If they

didn’t respond with aggressive margin expansions of their own (typically 300-400 bps), they ran

the risk of attracting unwanted attention from activist investors, like Trian and JANA, or 3G itself,

which intended to further consolidate the food industry. The activists looked at 3G’s early

success as proof that these big food companies were operating with excessive waste and

needed to tighten their belts.

These cutbacks could not have come at a more inopportune time. Big retailer customers like

Walmart, Kroger, and Target were taking the opposite approach in their investment strategies.

They abandoned their earnings guidance and margin targets and started making big

investments in price cuts for the consumer, data analytics to improve their category

management acumen, supply chain automation, e-commerce services to make shipping more

convenient, and their private label brands. They recognized they needed to do this to protect

their turf from Amazon’s expansion into the grocery industry and European hard discounters,

which were opening new stores in the U.S. Making these investments eventually boosted their

same-store sales growth and vastly increased their negotiating power over their CPG vendors.

They began to flex their negotiating power in very public and adversarial ways:

In 2017, Walmart announced its intention to push for price concessions of 15% in

category management meetings with its vendors to secure its reputation with consumers as

the low-cost provider. Kroger began to actively invest in price as well.

Walmart and Kroger pushed more responsibility for working capital management to their

vendors. They negotiated for longer terms on their payables, introduced new fees for

holding inventory, and threatened to fine vendors which failed to deliver products within

their new, more narrowed just-in-time delivery windows.

3.1%3.2%

3.4% 3.5%

3.8%4.1%

4.5%

4.8%

5.2%

5.5%5.7%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Organic Food Market Share Growth (%)

7 January 2020


Walmart and Campbell got into a very public dispute in 2017 regarding the canned soup

category when Campbell refused to agree to Walmart’s request for deeper price cuts to the

condensed soup product line. Walmart responded by reducing Campbell’s display activities

and expanding its private label offerings. Campbell eventually provided deeper price

concessions to Walmart a year later and rebased the margin structure of its soup products.

Kroger at its 2017 Investor Day signaled its intention to make private label expansion a

major element of its Restock Kroger plan to optimize its shelves and “right-size” categories.

In pasta, it said that private label is more popular with consumers than the brands. In

ketchup, it said that it wanted to put more variety on the shelf rather than give so much

space to multiple package sizes for one brand (probably Heinz).

“So disruption at shelf, what does this mean? Before I get into this, I want to emphasize, this

will be done in the categories where customers are telling us it matters. And in pasta, it matters.

If you own the stage, the store and you write the play, the planogram, you can determine who

the star is. And the customers have told us in this particular category, the star is our brands, the

star is private selection and we will make a statement with that. It's at eye level. When this

product is cut against branded products, it cuts better. It's right for customers, it's right for

Kroger and it's right for you.” Yael Cosset, Kroger Chief Digital Officer, 10/11/2017

A Less Treacherous Set-up for 2020

Reinvestment Has Stabilized Sales and Profit Trends

Starting in late 2017, big food companies began to recognize that they had cut back too far and

needed to initiate reinvestment plans to reverse the cost-cutting, restore their reputation as

category leaders, and regain negotiating power.

They also made expensive acquisitions of fast-growing entrepreneurial brands that had been

invading their categories. Or, in the case of Conagra and Campbell, they made transformational

acquisitions to create costs synergies and shift the weight of their portfolios into more attractive

categories. General Mills bought Blue Buffalo, Smucker bought Nutrish, Hershey bought

SkinnyPop, Conagra, bought Pinnacle Foods, and Campbell bought Snyder’s Lance.

Figure 4: We Believe That Food Companies’ Advertising Spending Grew 3% on Average in Their Fiscal 2019. However, it is Still

Down 10% From FY 14


2014 2015 2016 2017 2018 2019

Change

vs 2014

FY 19 vs.

FY 18

KHC 652 694 708 629 584 602 -10% 3%

HRL 114 145 204 136 152 131 32% -14%

K 1,094 898 736 731 752 752 -31% 0%

MDLZ 1,552 1,542 1,396 1,248 1,173 1,248 -24% 6%

CPB 411 385 397 327 327 347 -20% 6%

GIS 870 823 754 621 576 602 -34% 4%

CAG 396 330 347 328 279 253 -30% -9%

HSY 570 562 521 541 479 513 -16% 7%

SJM NA NA 170 170 194 238 39% 22%

Average -10% 3%

7 January 2020


Figure 5: Reinvestment and Portfolio Changes Have Returned Big Food Companies’ Sales Growth to Modestly Positive Territory

on Average

Source: Company data for CAG, CPB, GIS, HSY, K, KHC, MKC, MDLZ, SJM, Credit Suisse estimates

The bull case on the space is that these companies’ investments are driving sequential

improvement in organic sales growth, which makes the promise of margin expansion through

operating leverage more credible. On average, these investments and portfolio changes helped

organic growth rates improve to 1% by the end of the 2019 from close to -1%. In industries

like this one with significant operating and financial leverage, there is an enormous difference

between the value of long-term, discounted cash flows for companies with +1% growth than

those with -1%, especially in an environment with low discount rates.

For example:

Campbell reset its soup margins 400 bps lower at the start of FY 18 after getting into a

very public dispute with Walmart. Margins began to tip positive in its fiscal 3Q19 due to

significantly lower corporate costs.

Kellogg’s margins dipped lower again in 2019, but they showed signs of sequential

improvement in 3Q, and management claims they will stabilize in 4Q when the company

expects to come to the end of a 12-month cycle of investment.

Conagra’s fiscal 2Q20 indicated that its Pinnacle acquisition is back on track and that the

company is making progress toward achieving its rather aggressive 3-year FY 22 plan for

margin expansion and double-digit EPS growth.

General Mills’ operating margin is down 100 bps from its fiscal 2017 largely because it

needed to reverse a portfolio strategy that cut too much marketing support for soup, baking

products, and refrigerated dough and led to sharp sales declines.

(3.0%)

(2.0%)

(1.0%)

-

1.0%

2.0%

3.0%

Sales Price

7 January 2020


Kraft Heinz’s EBIT margin is down more than 700 bps from its peak after the company

recognized that it had cut back too far on marketing and internal capabilities to keep pace

with retailers’ demands and changing consumer trends.

Figure 6: EBIT Margins for Big Food Companies Are Down 130 bps on Average from

2016. In Our View, Campbell and Kellogg Have Invested Sufficiently In Their Margins

to Adjust to the Changing Needs of Consumers and Retailers

Source: Company data, Credit Suisse estimates, Based on Calendarized Estimates.

CAL EBIT 2016 2017 2018 2019E 2020E

Chg vs.

2016

CAG 15.3% 15.9% 15.3% 15.6% 16.6% 1.3%

CPB 18.2% 17.8% 16.2% 15.8% 15.8% -2.4%

GIS 17.3% 17.0% 16.5% 17.5% 17.2% -0.1%

HSY 20.4% 20.7% 20.6% 21.3% 21.8% 1.4%

K 15.4% 14.7% 13.9% 13.1% 12.9% -2.5%

MDLZ 15.3% 16.3% 16.7% 16.5% 16.8% 1.5%

KHC 27.3% 27.8% 23.2% 20.2% 19.5% -7.8%

SJM 19.9% 19.2% 19.5% 18.6% 18.3% -1.5%

Average 18.6% 18.7% 17.7% 17.3% 17.4% -1.3%

CAL GM 2016 2017 2018 2019E 2020E

Chg vs.

2016

CAG 29.1% 30.0% 29.3% 28.2% 28.1% -1.0%

CPB 37.6% 36.3% 33.9% 33.6% 33.5% -4.1%

GIS 35.9% 34.9% 34.1% 35.0% 34.7% -1.2%

HSY 45.6% 45.6% 44.0% 45.0% 45.5% -0.2%

K 39.2% 38.0% 35.6% 33.9% 34.0% -5.2%

MDLZ 39.7% 39.8% 40.1% 39.9% 40.4% 0.7%

KHC 38.8% 38.2% 34.8% 32.5% 32.3% -6.5%

SJM 38.8% 38.0% 37.9% 38.1% 37.9% -1.0%

Average 38.1% 37.6% 36.2% 35.8% 35.8% -2.3%

7 January 2020


Figure 7: Food Industry Gross Margin Appeared to Stabilize in

3Q19

Figure 8: Food Industry EBIT Margin Trends Turned Positive in

3Q19 But We Expect it To Decline in 4Q19 Due to Ongoing

Investment Needs

Source: Company data, Credit Suisse estimates. Includes CAG, CPB, GIS, HSY,

K, KHC, MDLZ, SJM. Excludes McCormick due to accounting changes

Source: Company data, Credit Suisse estimates. Includes CAG, CPB, GIS, HSY,

K, KHC, MDLZ, MKC, SJM

More Constructive Relationships with Big Customers

From what we can tell, the investment spending by the big food companies has helped stabilize

their relationships with the big retailers. In stark contrast to the highly public disputes and

pronouncements by retailers in 2017 and 2018, the tone in 2019 has turned much more

constructive. Perhaps Walmart and Kroger feel more comfortable with the ground they have

staked out versus Amazon and the European hard discounters. Or perhaps they have become

more satisfied with the services and investments that the big food vendors are providing. If so,

the thaw in the retailer-vendor relationships will create a more positive operating environment for

everyone.

Kroger

Our most meaningful takeaway from Kroger's analyst day in November 2019 was that Kroger

has come to the end of its long period of margin reinvestment. The last few years was about

evolving the business and investing heavily in price to meet the threat posed by new e-

commerce entrants like Amazon and hard discounters like Aldi and Lidl. This year, there was

little discussion about investing in gross margin and much more discussion about leveraging

assets. This is a change. With same store sales ("IDs") momentum now improving, Kroger

sounds comfortable shifting to a model of profitable growth. If gross margin investment were to

continue, we believe it would have pressured CPG players.

We also noticed a more constructive tone from Kroger regarding its relationships with big CPG

vendors. Management described big brands as fundamental to its strategy and pointed out that

18-20 of its top 25 CPG partners are growing with Kroger (with the top 5 growing very well).

This is a much more constructive tone than what we heard two years ago when Kroger

threatened the big vendors with private label and penalized them for missing on-time delivery

windows.

2.6%

1.2% 1.2%1.0%

0.0%

-0.3%

-0.7%

-1.0%-1.1%-0.9%

-1.9%-1.9%

-0.9%-0.7%

0.0%

0.2%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

2.6%

1.4%

2.1%

1.1%

0.3% 0.4%

0.0%

-0.1%0.0%

-0.1%

-1.4%

-1.0%

-0.5%-0.7%

0.3%

-0.1%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

7 January 2020


Walmart

Walmart has not verbalized a shift in its margin investment strategy as openly as Kroger, but we

have noticed a few changes around the edges:

1) Walmart’s rhetoric on pricing sounds less aggressive. Walmart opened the window for

CPG vendors to raise prices in January 2019 in response to higher freight and packaging costs.

In September 2019, at an investor meeting, management described itself as “pretty far along”

in its multi-year process of rolling out more aggressive prices in the food category to increase its

competitiveness regionally with only “a little more work to be done.” We think this means

Walmart will remain highly aggressive in food, but it doesn’t have plans to make significant price

investments on top off what it has already introduced. Management said it intends to keep

“constant downward pressure on food pricing,” but it described general merchandise as “the

next phase” in its efforts to drive price advantages.

2) Walmart is relying on big vendors to grow its snacks category. Walmart management

stated on its most recent earnings call that the snacks category was one of the primary drivers

of top line growth in its Grocery division. Our retail tracking data indicates that Walmart has

been partnering with the large cap food companies to fuel the growth, especially with Frito Lay,

Kellogg, Mondelez, Campbell, and Conagra. We were surprised to see Kellogg up 7.0% YTD in

the Nielsen-measured mass channel through October, Campbell up 3.4%, and Conagra up

8.7% YTD.

Figure 9: Frito Lay, Kellogg, and Campbell Achieved the

Largest Snacks Sales Growth in Nielsen’s Mass Channel in the

Last 12-weeks Ending 11/07/19

Figure 10: Kellogg and Mondelez Achieved the Largest Snacks

Sales Growth in all of Nielsen’s Channels Excluding Mass in

the Last 12-weeks Ending 11/07/19

Source: Nielsen, Credit Suisse. Mass channel is calculated as xAOC-Food-Drug.

Snacks includes Cookies and Crackers, Salty Snacks, Snack & Variety Packs, and

Sweet Snacks

Source: Nielsen, Credit Suisse. All Channels ex Mass includes Food, Drug, and

Convenience. Snacks includes Cookies and Crackers, Salty Snacks, Snack &

Variety Packs, and Sweet Snacks

3) Inventory reductions appear less aggressive. After three years of reducing its inventory

days outstanding to maximize cash flow, Walmart’s inventory is now growing faster than its

sales. This trend reversal probably comes more from Walmart’s hard goods category than food

because Walmart pulled forward purchases of goods from China ahead of expected tariffs.

However, it also might signal that the retailer wants to reduce out-of-stocks by carrying more

inventory at its stores and distribution centers.

Mass

Channel

12-week ending

11/07/19

YTD-ending

11/07/19

12-Week $

($ millions) YTD $ ($ millions)

Frito Lay 4.6% 6.8% $1,280 $4,726

Mondelez 3.0% 4.5% $525 $1,889

Kellogg 4.5% 6.9% $309 $1,112

Campbell 5.7% 3.4% $256 $891

Conagra 2.1% 8.7% $120 $439

Hershey 3.2% -0.7% $38 $133

All Channels

ex Mass

12-week ending

11/07/19

YTD-ending

11/07/19

12-Week $

($ millions) YTD $ ($ millions)

Frito Lay 2.4% 4.4% $2,433 $8,995

Mondelez 3.9% 3.8% $858 $3,110

Campbell 2.0% 1.8% $553 $1,970

Kellogg 7.1% 7.0% $444 $1,607

Conagra 1.2% 3.1% $212 $786

Hershey 1.9% 2.1% $71 $257

7 January 2020


Figure 11: Walmart’s Inventory is Now Growing Faster Than its Sales


Conservative Guidance Reduces Risk of Earnings Misses

In response to more challenging industry conditions, most of the management teams in the food

space have instituted more conservative targets for growth. This is especially true for companies

like Conagra, Campbell, and Kellogg, which are in the early stages of their turnaround plans.

We are generally in-line with the year one targets these companies have instituted; however, we

are very dubious about Conagra and Campbell’s ability to accelerate their revenue growth and

operating leverage in years two and three.

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Sales growth minus inventory growth, past 12 months

7 January 2020


Figure 12: Food Companies are Guiding to Less Than 1% Organic Revenue and EBIT Growth in the Current Fiscal Year. Excluding

Outliers (MKC and KHC), They are Guiding to 1% Organic Revenue and 1.5% EBIT.

Source: Company data, Credit Suisse estimates as of 12/17/19

Moderating Input Cost Inflation

Inflation is expected to decelerate modestly in 2020 compared to 2019. We think there is

potential for management teams to revise their inflation estimates lower during the course of

2020 as they begin to benefit from more favorable contracts with freight providers. Trucking

capacity expanded in 2019 after two years of very tight conditions. That said, the benefits from

lower freight might be partially offset by higher inflation in the protein markets owing to disease

issues in the Chinese pig herd from African swine fever.

Organic Revenue

Organic Revenue

Mid-Point EBIT Growth

EBIT

Growth

Mid-Point EPS Growth

EPS

Growth Mid-

Point

Campbell -1% to +1% 0% 0% to 2% (ex 53rd week) 1% Approx 7-9% ex 53rd week 8.0%

Conagra +1.0% to +1.5% 1.25% UNK UNK 3% to 8% incl 53rd week 5.5%

General Mills* 1% to 2% 1.5% 2.0-4.0%* 3% 3-5% 4.0%

Hershey 2% 2% approx 4-6% 5% 6-7% 6.5%

Kellogg** 1% to 2% 1.5% 0% 0% Down 10-11% -10.5%

Kraft Heinz approx -1.5% -1.5% approx -13-14% -14% approx down 20% -20.0%

McCormick 3-4% 3.5% 8-9%* 8.5% 6.5% to 7.5% 7%

Mondelez 3.5% 3.5% UNK UNK 5 to 7% 6%

Smucker -2.0% -2.0% approx -2% ex divest -2% -2% to 0% -1%

Average 0.4% 0.2% -0.7%

Average ex KHC, MKC 0.0% 1.5% 1.6%

General Mills

1-2% sales growth includes Blue Buffalo growth and excludes net benefit from 53rd wk, divestitures, and FX

2-4% EBIT growth assumes benefit from 53rd wk will be reinvested

Kellogg

Operating profit guidance provided ex-currency and excluding Keebler divestiture. EPS guide includes Keebler dilution

Smucker

EPS guidance includes about $40M of tough comparisons to last year's gain on sale and baking divestiture

7 January 2020


Figure 13: Dry Van Rates Are Well Below Prior Year Levels

Source: Company data, Credit Suisse estimates, CS Transportation team

Figure 14: Packaged Foods Companies Have Guided to Only a Small Deceleration of

Inflation in 2020 to 3.7% from 4.2% in 2019


-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

Jan-

15

Apr-

15

Jul-1

5

Oct-

15

Jan-

16

Apr-

16

Jul-1

6

Oct-

16

Jan-

17

Apr-

17

Jul-1

7

Oct-

17

Jan-

18

Apr-

18

Jul-1

8

Oct-

18

Jan-

19

Apr-

19

Jul-1

9

Oct-

19

Aug. / Sept. impact

from hurricanes

Spot price

reacceleration in Dec

Company FY14 FY15 FY16 FY17 FY18 FY19 FY20

CPB 4.0% >expected 1.5% 2.0% 2.7% 4.0% 3.0%

CAG 1-2% 3.0% -1.1% 1.1% 3.7% 2.7%-2.8% 2.7%-2.8%

GIS 4.0% 2.0% 2.0% 1-2% 4.0% 4.0% 4.0%

K 3-4% >expected Moderate NA Modest MSD <FY19

HSY* Inflation Neutral Neutral High >FY19

Average 3.1% 2.8% 1.2% 1.9% 3.7% 4.2% 3.7%

*Except for FY19, Hershey guidance includes food ingredients only, not packaging

7 January 2020


Figure 15: Food Inflation Is Poised to Moderate in 2020 compared to 2019 levels.

Source: FactSet, USDA, Company data, Credit Suisse estimates

Structural Challenges Remain In Place

Big Retailers Maintain Negotiating Power

The past few years marked a major tipping point in the relationships between big food

companies and their largest grocery customers that won’t reverse any time soon. Big grocers’

investments in e-commerce have given them more control over the point-of-sale than ever

before. Expansion of their private label programs has given them more leverage in price

negotiations and more visibility into their vendors’ cost structure. New tools to analyze the data

from their frequent shopper programs have given them more leverage to push back on vendors

if they make biased category management recommendations. One executive from a CPG

manufacturer told us that his company needed to increase investment in revenue management

tools to keep pace in the “data war” with its big customers.

Big food companies are investing more heavily in big data, e-commerce, and manufacturing

flexibility to keep pace with their customers’ needs, but these investments have pressured their

margins lower. Retailers appreciate these investments, but our sense is that they will continue

longer than investors realize, thus preventing margins from moving materially higher. For context,

packaged foods operating margins are still 100 bps higher than their long-term average while

the big retailers’ margins are still well below theirs.

Commodity 2019 Inflation Inflation 2020 Source

Beef -0.1% -3.6% CME

Cheese 48.0% -13.1% CME

Chicken*** -1.3% NA Urner Barry

Cocoa 4.5% -3.0% Factset

Coffee 27.5% 0.8% Factset

Corn 11.5% 0.2% Factset

Eggs -32.0% NA Factset

Flour 1.0% NA Factset

HFCS 1.0% NA Factset

Milk 11.1% 5.9% Factset

Pork 17.0% -2% Factset

Potatoes 13.9% NA USDA

Peanuts -10.5% NA USDA

Tree Nuts* 1.0% NA Factset

Tomatoes 21.0% NA USDA

Soybean Meal -2.1% 4.8% Factset

Sugar 11.5% 7.3% Factset

Vegetable Oil** 25.2% 3.5% Factset

Wheat 11.1% 1.3% Factset

*Almonds

**Soybean Oil

***We show boneless, skinless chicken breast

7 January 2020


Figure 16: Walmart’s Margins Moved Substantially Lower Over

the Past Five Years as It Prioritized Reinvestment; Packaged

Food Companies Began Reinvesting in 2018

Figure 17: Similar to Walmart, Kroger’s Margins Diverged with

Food Companies After 2015

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Distribution Losses

Just about all of the big food companies have lost distribution over the past four years.

Distribution losses accelerated in 2019 when Walmart and other retailers took more aggressive

steps to rationalize SKUs to improve in-store operational efficiency and optimize their sales.

They are now using more sophisticated analytical tools to make their own category management

decisions rather than relying on the vendors to tell them what to do.

For example, we heard from vendors in the frozen aisle that Walmart took these steps to

rationalize SKUs in the frozen aisle because it was worried about the risk of out-of-stocks in its

brick-and-mortar stores as they take on more responsibility for fulfilling e-commerce

transactions. Walmart is very worried about incidents where the consumer selects an item on

the website for Click-and-Collect then learns it is out of stock when arriving at the store. As a

result, Walmart is leaning toward dedicating more of its in-store inventory to high demand

“power SKUs” and less to tertiary items. We believe this is part of the reason why Walmart only

accepted 33% of Conagra’s new products for its Birds Eye brand and 40% of its legacy brands

in the frozen aisle in 2019.

On one hand, one could look at this as a positive for big food companies with power brands. All

else being equal, big food companies probably prefer the operational simplicity of manufacturing

and marketing fewer SKUs with longer production runs. Also, small challenger brands may find

it more difficult to gain distribution in an environment where retailers are putting more focus on

top sellers.

However, we find it much easier to believe in the long term growth prospects of companies that

are gaining distribution than the ones that are losing it. Big companies that have over-

proliferated into niche segments of the market will need to pull back their offerings and maybe

put limits on future proliferation. In addition, as brick-and-mortar locations take on added

responsibility for direct e-commerce fulfillment, Walmart could use its leverage to charge the

vendors higher fees for warehousing and shelf space. This would increase the cost of doing

business across vendors of all sizes.

4.0%

4.5%

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5.5%

6.0%

6.5%

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12.0%

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20

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E

PKG Avg (left) WMT US (right)

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2002

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E

PKG Avg (left) KR (right)

7 January 2020


Figure 18: Big Food Companies Continued to Lose Distribution in 2019, While Private Label Distribution Increased

Source: Company data, Credit Suisse estimates. Nielsen xAOC+C through November 2019. Private label estimate based on data through March 2019.

Private Label Expansion Continues

Walmart. Walmart has vastly expanded it private label capabilities. This marked a major shift

from its traditional point of difference, which was to leverage its vast scale in procurement and

distribution to provide consumers with the lowest every day price of big name CPG brands. By

relying too heavily on that approach, it fell behind major retailers like Kroger, Wegmans, and

H.E. Butt that had turned private label into a competitive advantage that drives store traffic.

In its effort to catch up, Walmart opened a new product development center, hired hundreds of

people from the CPG industry to develop a more effective strategy, and introduced higher

quality products, often with organic or natural ingredients. Several food manufacturers felt at

impact from this shift.

Kraft Heinz: In 2017, Walmart decided that its stores were over-indexed to Kraft Heinz’s

brands and expanded its private label offerings in cheese, meats, and nuts. The trend has

not stopped.

Conagra and B&G Foods: Since 2018, Walmart has been expanding space for its private

label frozen vegetables products. In 2019, it introduced new versions of Great Value frozen

dinners as well.

Smucker. Smucker had to roll back prices on peanut butter in 2019 after it allowed its

price gaps with private label to expand too far. Private label quality in this category has

improved.

Campbell Soup. Walmart and Campbell have resolved their dispute in the soup aisle, but

Walmart continues to expand its private label offerings in broth and ready-to-serve. In broth,

for example, we noticed that Walmart has placed its Great Value brand at eye level in the

middle of the shelf and placed Campbell’s Swanson brand at the bottom. The Great Value

brand’s packaging graphics are much more contemporary and higher quality than the

Swanson product.

Albertsons. Albertsons introduced 55 new private label products to the frozen aisle in 2019.

The line-up includes plant-based frozen bowls, plant-based meatless proteins (including

burgers), a Signature Select line of premium ethnic frozen bowls with recipes created by a New

Company 2014 2015 2016 2017 2018

Latest 52

wks

Last 12

wks

CONAGRA INC (1.2) (2.0) (3.2) (5.4) (2.3) (6.6) (7.4)

GENERAL MILLS 5.6 1.0 (3.4) (4.5) 0.8 (0.1) (0.2)

KELLOGG COMPANY (1.0) (3.4) (4.1) (3.5) (3.6) (0.2) 0.1

CAMPBELL SOUP CO 6.9 4.1 (2.4) (1.5) (3.0) (3.5) (3.2)

MONDELEZ INTERNATIONAL INC 4.8 (0.9) 0.2 3.8 2.0 (1.3) (1.3)

THE KRAFT HEINZ COMPANY (1.7) 0.1 (2.5) (3.6) (4.3) (2.1) (3.4)

THE HERSHEY CO 6.2 3.4 3.5 5.7 (0.1) (0.4) (2.1)

MCCORMICK & COMPANY, INC. 0.3 0.8 (0.8) (2.3) (4.0) (0.8) (1.1)

J. M. SMUCKER COMPANY, THE 3.7 4.7 1.0 (2.4) (0.6) (1.3) (1.0)

B & G FOODS INC. (2.0) (2.5) (2.4) (5.8) (5.5) (4.8) (5.0)

HORMEL FOODS CORPORATION 3.4 (3.6) (0.0) 1.9 (1.4) (3.9) (0.8)

TYSON FOODS INC 2.1 (3.4) (0.3) 2.5 (1.0) (4.0) (3.0)

Average 2.3 (0.1) (1.2) (1.3) (1.9) (2.4) (2.4)

Private Label 3.7 6.2 2.3 7.4 6.4 5.2 2.7

TDP % Change vs YA

7 January 2020


York City-based chef Suji Park, a Signature Select line of coffee-house inspired breakfast

sandwiches, O organics frozen breakfast “solutions,” and cauliflower-based mashed potatoes

and cheese bakes. Perhaps this is a sign that big grocery chains will make a bigger effort going

forward to capitalize on the innovation entering this space and the rising level of consumer

interest.

Kroger. Kroger sounds less combative about its private label strategy, but it continues to grow

at a rapid rate (+7%). What we find notable about Kroger's strategy is the degree to which it is

operating as a CPG company, with R&D, innovation and advertising. "We are not replicating

products, we are identifying trends and launching our own." Kroger is operating an "own brands"

business as a multi-category CPG participant with a captive retailer. Private label is 27% of

Kroger’s sales, well above the industry average.

As a result of these trends, categories such as cheese, frozen vegetables, snack nuts, and

single-serve coffee have seen significant private label expansion over the past year. In contrast,

retailers have reduced activity for breakfast cereal and ground coffee.

We view Hershey, Kellogg, and Mondelez as the most insulated from private label.

We view Conagra, B&G, and Kraft Heinz as the most exposed.

Private label activity in spice and seasonings and condensed soup has declined since the

prior year, which is a positive for McCormick and Campbell.

Figure 19: Private Label Has Made Substantial Share Gains in Cheese, Single-Serve Coffee, Ready-to-Serve Soup, Snack Nuts,

and Frozen Vegetables over the Past Year (52 Weeks Ending November 30, 2019) Across Nielsen-Measured Channels. In

Contrast, Retailers Have Reduced PL Activity in Breakfast Cereal, Refrigerated Dough, Condensed Soup, and Ground Coffee

Source: Company data, Credit Suisse. Nielsen xAOC+C since 11/30/19

2.1

1.5 1.4 1.4 1.41.3

1.1 1.00.8

0.6 0.60.5 0.4

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7 January 2020


E-Commerce Poses Challenges and Opportunities

Big food companies claim that e-commerce and digital marketing represent a big opportunity for

them to leverage their scale and improve the ROI on their marketing spending. In theory, the big

companies ought to be able to outspend the small ones on data analytics and use the consumer

insights to increase their importance to their retailer customers. In addition, their digital

marketing tools give them the ability to customize their marketing messages based on

consumers’ past purchase history. Conagra, for example, estimates that shifting to more

“personalized communication” has led to a 50% reduction in wasted media impressions and

product development. This includes using data scraping rather than lengthy consumer testing to

develop new recipes. Similar to other CPG companies, it is now customizing the marketing of its

Healthy Choice meals products based on dietary preferences.

But from what we can tell, the consumers capture most of the value while retailers and

manufacturers absorb the cost to execute it. Consumers who shop in an omni-channel

environment expect the retailers to provide a seamless shopping experience without charging

too much of a premium for the convenience. Walmart, Kroger, and Target have made

considerable investments in e-commerce and supply chain flexibility to keep their consumers

happy. Walmart’s e-commerce business is growing at a 40% rate, and Click-and-Collect is now

in 2,100 stores with plans to be in 3,000-4,000 stores. Kroger’s digital revenue is growing at a

30% pace versus year-ago levels, with more than 2,000 stores offering grocery pickup and

over 2,300 offering home delivery.

By making these investments, the retailers have taken greater control over the point of sale

interaction with shoppers and they have found creative ways to charge fees to their vendors for

the privilege of participating in them. For example, Kroger will charge a premium to

manufacturers who wish to have their brands show up first during a category search online or

when consumers are creating an online shopping list.

Manufacturers don’t have to make as big of investment as their retailers, but they need to treat

e-commerce as incremental channel that requires incremental investment rather than a

substitute for traditional brick-and-mortar. This includes higher spending on shopper insights,

“slotting” allowances for preferable placement on the retailers’ e-commerce sites, and

investments in packaging and distribution flexibility.

Despite the higher spending, we have noticed that many of the small companies are actually

more skilled than the big ones at marketing and selling their brands in the e-commerce world.

Culturally, it is more difficult for a big company with 50+ years of investment in traditional brick-

and-mortar to shift its priorities. Small companies, on the other hand, can build their

organizations around e-commerce from their very start because it offers an “infinite shelf” and

the lowest barriers to entry. Having a younger workforce that grew up in a digital environment

tends to be a positive as well.

Pros and Cons of Precision Marketing

Kroger management has articulated a strategy and laid out specific financial targets for

monetizing its investments in e-commerce and consumer advertising into “alternative revenue”

streams. A big component of this strategy is “Precision Marketing," which is a developing

media/point-of-sale marketing opportunity available to suppliers. We would expect this channel

to continue to grow as CPG suppliers re-allocate marketing dollars from other media channels.

According to Kroger, the retailer has engaged 1,000 CPG brands so far with 90% retention.

Kroger estimates this market to be $13b.

Some food company management teams find programs like these attractive because it

theoretically provides a higher ROI than advertising directly to consumers through traditional

mediums. One of the unique elements of the program is that it can “close the loop” with the

consumer after it detects conversion to a sale. While we do not have hard data to refute this

assertion, we think it is fair to say that the manufacturer loses a high degree of control over the

7 January 2020


dollars it spends and the advertising message it can convey when it goes through an

intermediary. Brands tend to lose connectivity with their consumers when they stop

communicating with them directly.

Our concern is that Precision Marketing might give Kroger implicit negotiating power with

manufacturers when making category management decisions. If a manufacturer decides not to

participate, Kroger might decide to allocate less shelf space to its brands. Kroger insists that

there is no quid pro quo in this program, but this might change. By making its quantitative

alternative profit target so publicly visible for investors and internal constituents ($125-$150M

for FY 20), it is sending a pointed message to its organization to pursue it in an aggressive

manner.

TV Advertising No Longer a Barrier to Entry

The large competitive advantages that the big food companies built up over the years by

advertising on television and dominating the shelves of brick-and-mortar stores have declined.

Social media and digital advertising give the start-up brands a way to reach “social influencers”

without having to spend $20 million on a national advertising campaign. The Annie’s and KIND

brands, for example, reached $200 and $500 million in sales respectively without spending

money on national TV.

“Our marketing is good, often excellent. We won 17 awards, we're top-rated in both the Effie's

and the Work Report, and it confirms the effectiveness of our advertising. But marketing is

changing quickly. The marketing abilities of yesterday are no longer fit for today, far less

tomorrow, and we must ensure that the propositions of our brands are rooted in new deep

consumer insights and have purpose embedded in them.” Unilever CEO Alan Jope, November

13, 2019

In addition, large brick-and-mortar retailers usually waive their typical demands for “slotting

allowances” for smaller brands because they want to attract younger consumers to their stores

and because they recognize that they do not have big budgets. Ironically, the large retailers

become more demanding on the startups after the deep-pocketed big food companies acquire

them, thus further pressuring the big companies’ advantages of scale.

Supply Chain and Distribution Advantages Have Eroded

Big companies have increased their reliance on third-party manufacturers and brokers to reduce

their asset footprint and reduce their capital-at-risk. This fueled new investment into the co-

packing industry and led to excess capacity. As an example, the number of pages in the Private

Label Manufacturers Association’s trade show program guide has increased 35% since 2010.

Moreover, unlike the soft drink and beer industry in which small companies heavily rely on the

big companies’ distribution networks to get directly on customers’ shelves, the small food

companies easily gain access to retailers’ distribution centers through third-party truckers.

We believe Kraft Heinz is an example of a company that experienced a negative impact from

consolidating its supply chain too aggressively. After merging Kraft and Heinz in 2015, it

reduced the number of its North American manufacturing facilities to 44 from 55. This led to

distribution losses in 2017 for frozen potatoes and sliced lunchmeats when its remaining

facilities ran into start-up problems and weather-related shutdowns.

Supply chain consolidation has also made it difficult for Kraft Heinz to pivot to growth. In 2018,

it shifted its executive compensation metrics in the middle of the year to sales growth instead of

EBITDA and launched a plethora of new products to the market. These new products

introduced more complexity to the supply chain because they required smaller batch sizes and

greater use of co-packers. When its supply chain proven unable to meet the demands of

customers, it incurred significant upcharges for last-minute freight and co-packing. By the end

of the year, it had missed its supply productivity targets. For 2020, Kraft Heinz intends to pivot

to a new strategy of “fewer, bigger, better,” which we believe is designed to reduce pressure on

supply chain execution.

7 January 2020


Pricing Power Has Diminished

We can see the lingering effects of the big food companies’ loss of negotiating power when we

analyze their pricing trends. Earlier this year, most of the food companies claimed that they had

successfully raised pricing in North America to offset higher freight and packaging costs. Pricing

did move higher, but not to a material degree. Overall North American sales trends have been

tracking below 1% since mid-2018.

Figure 20: North American Sales Growth Averaged Only 0.5% in 3Q19 With Net

Pricing Up Only 0.7%


The management teams of the big food companies insist that their relationships with big

retailers have not changed. Price negotiations are difficult, they say, but no different from how

they were in the past. From our perspective, the environment is now actually much tougher.

As evidence of declining pricing power, the charts below show a widening difference between

the price increases that retailers charge consumers at their stores and the net price increases

that the big food companies report in their financial results. Retail pricing for these companies’

products has risen at an average annual pace of 2% on average over the past five years for U.S.

consumers. However, the food companies’ price realization over that time has been close to

zero. In fact, the difference between the price increases reflected at retail and the pricing

reported by the manufacturers keep expanding. We believe the expanding gap reflects the

retailers’ ability to capture a larger piece of the value chain. This includes pushing the vendors

for bigger promotional discounts and demanding higher fees for access to consumer data and

retailer marketing programs.

(3.5%)

(3.0%)

(2.5%)

(2.0%)

(1.5%)

(1.0%)

(0.5%)

-

0.5%

1.0%

1.5%

NA Reported Sales NA Reported Price

7 January 2020


Figure 21: Retailers Have Increased Pricing for Big Food

Companies’ Products by 2% on Average, but the Food

Companies’ Price Realization Has Been Close to Zero.

Figure 22: The Difference Between the Price Increases

Reflected at Retail and the Pricing Reported by the

Manufacturers Keeps Expanding

Source: Company data, Credit Suisse. Nielsen xAOC+C. Companies in the average

include K, MDLZ, KHC, SJM, GIS, CPB, HSY, and CAG

Source: Company data, Credit Suisse estimates. Nielsen xAOC+C. Companies in

the average include K, MDLZ, KHC, SJM, GIS, CPB, HSY, and CAG.

Portfolio Changes Have Increased Debt and Raised Risk Profiles

Many big companies recognized that they need to revamp their portfolios to improve their

growth rate. This entailed a) acquiring fast-growing, entrepreneurial brands that already have a

strong consumer following and theoretically benefit from leveraging a big company’s scale, b)

using acquisitions to shift the weight of the portfolio mix further away from declining categories,

and c) divesting declining brands that have become too antiquated to resuscitate.

General Mills, for example, bought Blue Buffalo in 2018 and stated its intention to divest

5% of its portfolio over time.

Smucker sold its Pillsbury baking business and bought the Nutrish brand.

Kellogg bought RXBAR, entered a JV in Nigeria, and sold its Keebler business.

Hershey bought SkinnyPop and, more recently, One Brands.

Campbell bought Snyder’s Lance and sold Bolthouse and Arnott’s.

Investors often wonder why these companies lack the entrepreneurial spirit internally to create

breakthrough new products and new pockets of demand on their own. In our experience, the

big companies that already operate at very high returns on capital have difficulty approving high

risk, high reward ideas that, by definition, dilute those returns. They would rather allocate capital

to lower-risk line extensions for their proven brands, even though they rarely generate category

growth.

-1.0%

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1.0%

1.5%

2.0%

2.5%

3.0%

2013 2014 2015 2016 2017 2018 2019E

Annual NA Pricing Annual Retail Pricing

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

2013 2014 2015 2016 2017 2018 2019E

7 January 2020


Figure 23: We Estimate That About 34% of the U.S. Food Companies’ Portfolio Face

Structural Challenges in the U.S. Market

Source: Company data, Credit Suisse estimates. Nielsen xAOC+C through 2019

Figure 24: Packaged Foods Companies Have Paid Premium EV/EBITDA Multiples for

Acquisitions over the Past Year

Source: Company data, Credit Suisse

We have yet to see much evidence that these transactions have boosted organic growth rates.

Of more concern, the transactions have increased the risk profile of their businesses by

extending them into unfamiliar categories (particularly pet food), increased their debt loads, and

diluted their margins. In many cases, they have to operate these acquired businesses

independently so as not to crush their entrepreneurial spirit. This makes it difficult to maximize

synergies.

While we agree that these companies needed to take more aggressive measures to return to

growth, we are concerned that they are destroying capital. They are paying huge multiples for

Company Good Stable

Structurally

Challenged

KHC 28% 19% 53%

CPB 42% 13% 45%

CAG 18% 38% 44%

K 55% 3% 42%

SJM 26% 39% 35%

HRL 44% 26% 30%

GIS 16% 59% 25%

MKC 45% 34% 21%

HSY 40% 50% 10%

Average 35% 31% 34%

25.1

22.021.4

19.5 19.1

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14.013.0

10.210.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

7 January 2020


businesses outside of their core competencies while they are selling businesses that would have

contributed large incremental returns if management had simply marketed them more effectively.

As a result of these transactions, these stocks have not held up as well as they historically have

during nervous periods in the market. Investors do not want to own companies with unstable

profit margins, integration risk, and high financial leverage in a rising risk environment. To make

matters more challenging, the boards of many of these companies have had to suspend share

repurchases or even freeze their dividends. The loss of flexibility in their capital structures makes

it difficult for the boards to protect their falling share prices. If sales turn negative again, there is

a risk that these companies will feel rushed to make more divestitures in coming years to pay

down debt and further dilute their earnings.

Figure 25: Several Food Companies Have Made Acquisitions and Divestitures That Intrinsically Diluted Their Operating Margins


Figure 26: B&G Foods, Smucker, Conagra, Kraft Heinz’s Financial Leverage Increased in FY 19 While General Mills, Kellogg, and

Campbell’s Leverage Decreased. Several of Our Companies Have Had to Suspend Share Repurchases or Even Freeze Their

Dividends Following Transformational M&A


Core

Sales

($M)

FY 18 Core

Margin Divested Proceeds

Divested

Sales

($M)

Divested

Margin

(Estimate) Acquired Consideration

Acquired

Sales

($M)

Acquired

Operating

Margin

(Estimate)

Net Accretion

/ (Dilution) to

Margin

Campbell Soup 7,900 17.0% Arnott's* $2.5-$3.0B EST 1,100 18% Snyder's-Lance $6.1B 2,200 9% -2.1%

Bolthouse* 900 0%

Conagra 7,938 15.3% Wesson $180M 160 20% Pinnacle Foods $10.9B 3,000 14.7% -0.2%

General Mills 15,750 16.6% Green Giant** 570 16% Blue Buffalo $8B 1,400 19% 0.2%

Hershey 7,500 21.0% Amplify*** $1.6B 250 30% 0.3%

7,500 21.0% Pirates*** $420M 95 15% -0.1%

Kellogg 12,850 14.5% Keebler Cookies TBD 900 14.5% RXBAR $600M 200 10% -0.1%

Kraft Heinz 26,000 22.0% Canada Cheese $1.23B 430 25% Primal Kitchen $200M 50 10% -0.1%

26,000 28.0% Complan India $630M 150 20%

26,000 28.0%

Smucker 7,357 19.5% Baking Business $375M 370 17% Ainsworth $1.9B 800 11% -0.8%

Debt/EBITDA FY 16 A FY 17A FY18A FY 19E/A FY 20E Share Repurchase Dividend

B&G Foods 5.3 6.0 5.2 6.2 6.3 Repurchased 1.4M shares Sept YTD. $25.3M

available of $50M program

Frozen

Campbell 1.8 1.8 5.9 5.0 3.5 Suspended Frozen

Conagra 3.2 1.8 2.5 5.7 4.9 Suspended Frozen

General Mills 2.3 2.5 4.6 3.9 3.6 Suspended Frozen

Hershey 1.5 1.4 2.0 1.9 1.8 Repurchased 3.5M shares YTD ($490M) 3Q19 Raise

Kellogg 3.0 3.5 3.6 3.3 3.3 Repurchased 4M shares YTD ($220M) 3Q 19 Raise

Kraft Heinz 3.6 3.8 4.3 4.6 4.8 Immaterial 4Q 18 Cut

McCormick 1.7 5.1 4.1 3.3 2.8 Suspended 1Q 19 Raise

Mondelez 3.4 3.4 3.4 3.4 3.4 Repurchased 24M shares ($1.2B) in 2019. $3.5B

remaining in program

3Q19 Raise

Smucker 3.2 3.1 2.8 3.4 3.1 Reduced pace Oct 18 Raise

TreeHouse Foods 4.2 4.2 4.2 4.2 4.2 Immaterial none

Average 3.0 3.3 3.9 4.1 3.8

7 January 2020


Of course, the flipside to financial leverage is that equity investors can make outsized returns if

free cash flow proves sufficient to pay down the debt at a good pace. From a historical

perspective, we note that Smucker, Campbell, and Conagra generated the strongest degree of

free cash flow to pay down debt after covering their dividends. In contrast, Kraft Heinz and B&G

Foods did not generate sufficient free cash flow to support their capital structures. Kraft Heinz

has cut its dividend and may need to cut it again. We continue to believe that B&G will need to

cut its dividend as well.

Figure 27: By Our Estimates, Smucker and McCormick Will Have the Most Free Cash

Flow Available to Pay Down Debt Over the Next Two Years After Paying Its Dividend.

Kraft Heinz and B&G Foods Dividend Payments Have Exceeded Their Free Cash Flow


Melting Glaciers, Not Ice Cubes

Because of these pressures, we view big food companies as “melting glaciers” that are slowly

shrinking in relevance. We use melting glaciers as our analogy rather than melting “ice cubes”

because these companies are still very big and visible at retail and because the erosion occurs

slowly, not quickly. With enough effort and enough resources, these big companies could arrest

their declines. However, we believe they have not made enough sacrifices yet to stabilize their

businesses.

Dividend as % of FCF 2014 2015 2016 2017 2018 2019 2020

Past 3-Year

Avg

Kraft-Heinz 85% 269% -417% 182% 84% 82% 238%

B&G Foods 91% 73% 44% -928% 76% -6899% 100% 251%

Kellogg 56% -68% 64% 65% 80% 139% 64% 86%

Hershey 89% 53% 63% 48% 42% 42% 55% 44%

General Mills 52% 56% 56% 70% 51% 46% 58% 54%

Mondelez 50% 46% 68% 76% 48% 48% 54% 54%

McCormick 52% 44% 43% 38% 42% 48% 47% 43%

Campbell 71% 49% 35% 44% 47% 57% 62% 49%

Conagra 44% 42% 70% 44% 47% 47% 40% 46%

Smucker 41% 52% 25% 39% 39% 48% 73% 42%

7 January 2020


Figure 28: Like Melting Glaciers, the Big Food Companies Have Seen Their Competitive Advantages Slowly Eroded by Changing

Consumer Preferences and Lower Barriers to Entry.

Source: Credit Suisse

Organic and

Whole Foods

Consumer

fragmentation

Media

fragmentat ion

7 January 2020


2019 Review and 2020 Outlook

Large-cap packaged food stocks grew 32% in 2019 (as of December 31st), outperforming

staples peers. However, they only grew 5% on average over a two year period,

underperforming the staples group average and the broader S&P 500.

Figure 29: Large-Cap Food Stocks Outperformed Staples Peers in 2019 but Have

Underperformed Broader Staples and the S&P 500 Since 2017

Source: FactSet, Credit Suisse estimates

Outperformance from Campbell, Hershey, Mondelez, and Conagra came from a recovery in

their valuation multiples rather than changes to forward earnings estimates. General Mills was

the only company with a material degree of positive earnings revisions. Conagra, Campbell, and

Kellogg’s earnings revised lower, but the stocks moved higher due to higher valuation multiples.

Kraft Heinz and B&G Foods’ stock prices fell largely in synch with their downward earnings

estimates.

Food Companies 12/31/2017 12/31/2018 10/2/2019 12/31/2019Since

12/31/17

Since

12/31/1890 day

Kraft Heinz $78 $43 $27 $32 -58.7% -25.3% 21.0%

Mondelez $43 $40 $54 $55 28.7% 37.6% 2.0%

General Mills $59 $39 $53 $54 -9.7% 37.5% 1.2%

Kellogg $68 $57 $62 $69 1.7% 21.3% 11.6%

Hershey $114 $107 $154 $147 29.5% 37.1% -4.3%

Conagra $38 $21 $28 $34 -9.1% 60.3% 20.9%

Campbell $48 $33 $46 $49 2.7% 49.8% 7.1%

Smucker $124 $93 $107 $104 -16.2% 11.4% -2.5%

B&G $35 $29 $19 $18 -49.0% -38.0% -3.4%

McCormick $102 $139 $165 $170 66.5% 21.9% 3.0%

Tyson $81 $53 $82 $91 12.3% 70.5% 10.5%

Food Average (ex B&G Foods) 4.8% 32.2% 7.1%

Beverages

Coke $46 $47 $53 $55 20.6% 16.9% 4.3%

Pepsi $120 $110 $134 $137 14.0% 23.7% 2.0%

Monster $63 $49 $55 $64 0.4% 29.1% 15.3%

Molson Coors $82 $56 $57 $54 -34.3% -4.0% -5.0%

Anheuser Busch $93 $58 $83 $73 -21.9% 26.0% -12.5%

Beverage Average -4.2% 18.3% 0.8%

Household Products

Colgate $75 $60 $71 $69 -8.8% 15.7% -2.4%

Clorox $149 $154 $149 $154 3.2% -0.4% 2.8%

Estee Lauder $127 $130 $192 $207 62.3% 58.8% 7.6%

Kimberly Clark $121 $114 $140 $138 14.0% 20.7% -1.6%

Proctor & Gamble $92 $92 $121 $125 35.9% 35.9% 3.2%

Church & Dwight $50 $66 $75 $70 40.2% 7.0% -6.0%

Household Products Average 24.5% 22.9% 0.6%

Staples Average 8.3% 24.5% 2.8%

S&P 500 2,674$ 2,507$ 2,888$ 3,231$ 20.8% 28.9% 11.9%

7 January 2020


Figure 30: Calendarized EPS Declined -3% on Average in 2019, Including Significant Downward Revisions for Conagra, Campbell,

and Kellogg. General Mills EPS Estimates Revised Significantly Higher. Campbell Estimates Revised Lower due to the Divestiture

of Arnott’s

Source: FactSet, Company data, Credit Suisse estimates

Figure 31: P/E Valuation Multiples in the Food Space Rebounded in 2019 and Are Now Above Where They Were at the Start of

2018. We Believe CPB’s Valuation Will Re-Rate Lower. We Believe MDLZ’s Multiple Will Re-Rate Higher as Organic Growth

Accelerates.

Source: Factset, Company data, Credit Suisse estimates, P/E multiples as of the first day of each calendar year. Data as of 01/02/20

2012A 2013A 2014A 2015A 2016A 2017A 2018A

2019E at

1/02/19

2019E at

1/02/20 2020E

CAG 16% 4% 1% 8% 9% 24% 17% -5% -14% 15%

CPB 1 3% 2% 4% 9% 1% -7% -14% -2% -11% 5%

GIS 8% 1% -1% 13% -4% 3% 1% 1% 8% 1%

HSY 15% 15% 8% 3% 7% 8% 13% 5% 7% 7%

K 2 -3% 5% 1% -9% 4% 7% 8% 0% -9% 3%

KRFT / KHC NA 5% 4% NA NA 7% -1% 6% -20% -9%

MDLZ 7% 10% 15% 0% 21% 10% 13% 3% 3% 6%

MKC 9% 3% 8% 5% 9% 13% 15% 8% 8% 4%

BGS 36% -1% -13% 10% -9% 6%

SJM 3 12% 10% -1% -1% 15% -4% 3% 0% 0% 0%

Average ex-BGS 8% 6% 4% 4% 8% 7% 6% 2% -3% 3%

1. For comparability, CY12 and CY13 grow th rates adjusted to consider the sale of European business.

CY16 CY 15 adjust for the change in pension accounting methodology.

2. CY12 results exclude the accounting restatement for comparability.

3. CY16/17 excludes amortization expense

4. Tax reform benefit depicts 2018 EPS grow th benefit from a low er tax rate compared to 2017's tax rate

2012 2013 2014 2015 2016 2017 2018* 2019 2020

CAG 14.0 13.6 13.6 16.4 17.9 21.4 16.6 10.0 15.2

CPB 13.7 13.4 16.4 15.9 18.5 19.0 15.7 13.1 20.4

GIS 14.8 14.4 16.7 16.8 19.6 19.5 17.2 12.3 15.2

HSY 19.8 20.1 23.6 24.1 20.2 21.8 19.9 19.0 23.4

K 14.3 15.0 15.2 18.3 19.6 18.4 14.5 13.2 16.8

KHC NA 15.1 17.1 19.4 24.6 21.9 18.4 11.6 12.3

MDLZ 14.8 16.1 20.2 20.5 22.2 21.1 17.8 16.1 20.4

MKC 16.3 18.8 20.0 20.4 23.0 22.6 20.3 25.6 30.0

BGS 16.7 18.1 14.2 13.0 9.8

SJM 14.5 15.6 16.5 17.7 19.7 16.2 14.5 11.5 12.5

Average ex-BGS 15.3 15.8 17.7 18.8 20.6 20.2 17.2 14.7 18.5

1. Kellogg's P/E multiple rerates 1.0x lower beginning 2014 due to pension accounting change

2. Smucker's P/E multiple rerates 1.0x lower beginning 2017 due to accounting change for amortization expense

2018 P/E M ultiples lowered by 1.5x to adjust for Tax Reform benefits not yet expressed in consensus as of 1/1/18

7 January 2020


We expect organic sales growth to stay at 1% on average in calendar 2020, essentially in-line

with the 2019 performance. Forward consensus implies a fair degree of margin expansion in

2020 from operating leverage.

Figure 32: Forward Consensus Estimates as of 01/02/20, Calendarized

Source: FactSet Consensus Estimates, Company data, Credit Suisse estimates

2014A 2015A 2016A 2017A 2018A

2019E as of

1/02/19

2019E as of

1/02/20 2020E

CAG 1.55$ 1.92$ 2.25$ 2.14$ 1.93$ 2.21$

CPB 2.60$ 2.97$ 2.99$ 2.97$ 2.55$ 2.51$ 2.26$ 2.38$

GIS 2.70$ 3.06$ 3.02$ 3.10$ 3.14$ 3.16$ 3.40$ 3.42$

HSY 4.12$ 4.41$ 4.76$ 5.36$ 5.64$ 5.75$ 6.14$

K 3.74$ 4.00$ 4.31$ 4.31$ 3.93$ 4.03$

KRFT / KHC 3.33$ 3.55$ 3.51$ 3.72$ 2.81$ 2.56$

MDLZ 1.62$ 1.94$ 2.14$ 2.42$ 2.49$ 2.50$ 2.66$

MKC 3.82$ 4.32$ 4.97$ 5.39$ 5.35$ 5.58$

BGS 2.07$ 2.12$ 1.84$ 2.03$ 1.68$ 1.78$

SJM 7.88$ 8.14$ 8.16$ 8.15$ 8.14$

7 January 2020


Figure 33: Consensus Estimates Imply a Significant Rebound in Operating Profit Growth in 2020 to 4% (Excluding Impact of

Divestitures)

Source: FactSet estimates as of 12/23/19, Company data, Credit Suisse estimates

Figure 34: We Expect Organic Growth of 1% in 2020, Still Below Historical Averages

Source: Company data, Credit Suisse estimates, Includes CPB, CAG, GIS, HSY, K, KHC, MDLZ, MKC, SJM

Calendar 2018 HISTORY CONSENSUS EXPECTATIONS CAL 2019 CONSENSUS EXPECTATIONS CAL 2020

2017 2018

%

Change 2018 2019E

%

Change 2019E 2020E

%

Change

BGS 328 314 -4% BGS 289 304 5% BGS 289 297 3%

HSY 1,558 1,607 3% HSY 1,607 1,704 6% HSY 1,687 1,773 5%

K 1,879 1,880 0% K 1,822 1,763 -3% K 1,694 1,763 4%

KHC 7,770 7,024 -10% KHC 7,024 6,060 -14% KHC 6,174 5,629 -9%

MDLZ 4,119 4,322 5% MDLZ 4,322 4,260 -1% MDLZ 4,264 4,459 5%

MKC 720 715 -1% MKC 930 988 6% MKC 970 1,026 6%

CAG 1,203 1,202 0% CAG 1,202 1,184 -1% CAG 1,626 1,773 9%

CPB 1,302 1,095 -16% CPB 1,282 1,278 0% CPB 1,287 1,294 1%

GIS 2,613 2,601 0% GIS 2,601 2,602 0% GIS 2,899 2,980 3%

SJM 1,422 1,401 -1% SJM 1,432 1,422 -1% SJM 1,441 1,435 0%

Average ex KHC -2% Average ex KHC 1% Average ex KHC 4%

BGS Excluded Pirates Divestiture BGS: Excluded Pirates divestiture

CAG: Excluded Pinnacle acquisition CAG: CAG: Excluded Pinnacle CAG: Created a Pro Forma for Pinnacle in prior period

SJM: Excluded Ainsworth CPB: Removed International and created PF for Snyders 4Q18CPB: Removed International

CPB: Excluded Snyder's Lance SJM: Excluded divested baking business SJM: Pro Forma for Baking divestiture

GIS: Excluded Blue Buffalo acquisition K: Excluded divested Keebler business K: Pro Forma for Keebler divestiture

MKC: Excluded RB Foods acquisition GIS: Excluding Blue Buffalo acquisition GIS: PF Blue Buffalo acquisition

BGS and KHC are EBITDA estimates BGS and KHC are EBITDA estimates

3.7%3.3%

4.3%

6.0%

2.3%

1.5%

3.4%

1.4%

-0.4%

1.0%

-0.3%-0.6%

0.6%1.0%

1.2%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

2005 2006 2007 2008 2009 2010 2012 2013 2014 2015 2016 2017 2018 2019E 2020E

7 January 2020


Figure 35: We Expect Only 1% Pricing On Average in 2020, Similar to 2019

Source: Company data, Credit Suisse estimates. Includes CPB, CAG, GIS, HSY, K, KHC, MDLZ, MKC, SJM

Figure 36: We Expect Gross Margins to Remain Flat in 2020, Well Below Peak Levels

in 2016

Source: Company data, Credit Suisse estimates, Includes CPB, CAG, GIS, HSY, K, KHC, MDLZ, MKC, SJM

(3.0%)

(2.0%)

(1.0%)

-

1.0%

2.0%

3.0%

Sales Price

37.7%37.7%

37.1%

36.9%

36.9%

36.2%

34.8%

36.9%

37.7%

36.7%

35.8%35.9%35.5%

37.1%

38.1%

37.6%

36.2%

35.8%35.8%

33.0%

34.0%

35.0%

36.0%

37.0%

38.0%

39.0%

17-year average 36.8%

7 January 2020


Figure 37: We Expect Operating Margins to Remain Flat in 2020, Well Below Peak

Levels in 2016

Source: Company data, Credit Suisse estimates. Includes CPB, CAG, GIS, HSY, K, KHC, MDLZ, MKC, SJM

Figure 38: EBIT Margins are Down 130 bps Since 2016; Gross Margins are Down 230 bps.


As a result of our assumptions, we are below consensus EPS for B&G Foods, Conagra, Kraft

Heinz, and Smucker for fiscal 2020. We are also below consensus for Campbell’s fiscal 2021.

For Kellogg, we are below consensus for 2020 due to technical factors related to the divestiture

of Keebler assets, but about consensus for 2021.

17.2%17.0%

16.6%16.1%16.0%

15.1%

13.9%

15.3%15.3%15.1%14.7%

15.0%

15.8%

17.0%

18.6%18.7%

17.7%17.3%

17.4%

12.0%

13.0%

14.0%

15.0%

16.0%

17.0%

18.0%

19.0%

20.0%

17-year average 15.9%

CAL EBIT 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E

Chg vs.

2016

CAG 10.2% 10.2% 10.4% 10.1% 10.0% 11.7% 15.3% 15.9% 15.3% 15.6% 16.6% 1.3%

CPB 16.6% 16.4% 15.6% 14.6% 15.2% 18.1% 18.2% 17.8% 16.2% 15.8% 15.8% -2.4%

GIS 17.4% 17.1% 16.8% 15.9% 15.5% 17.1% 17.3% 17.0% 16.5% 17.5% 17.2% -0.1%

HSY 17.7% 17.9% 18.5% 19.2% 19.6% 20.0% 20.4% 20.7% 20.6% 21.3% 21.8% 1.4%

K 16.1% 15.0% 14.1% 14.6% 14.8% 14.3% 15.4% 14.7% 13.9% 12.9% 12.8% -2.6%

MDLZ 12.1% 12.1% 12.9% 13.1% 15.3% 16.3% 16.7% 16.5% 16.8% 1.5%

KHC 14.6% 16.6% 18.9% 21.5% 27.3% 27.8% 23.2% 20.2% 19.5% -7.8%

SJM 16.4% 16.2% 16.9% 19.5% 19.9% 19.9% 19.2% 19.5% 18.6% 18.3% -1.5%

Average 15.3% 15.1% 14.7% 15.0% 15.8% 17.0% 18.6% 18.7% 17.7% 17.3% 17.4% -1.3%

CAL GM 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E

Chg vs.

2016

CAG 24.3% 25.0% 24.0% 24.0% 26.0% 28.0% 29.1% 30.0% 29.3% 28.2% 28.1% -1.0%

CPB 40.5% 39.5% 38.0% 36.3% 34.3% 37.0% 37.6% 36.3% 33.9% 33.6% 33.5% -4.1%

GIS 39.0% 37.9% 36.9% 35.6% 34.7% 35.6% 35.9% 34.9% 34.1% 35.0% 34.7% -1.2%

HSY 42.9% 42.4% 43.8% 46.0% 44.9% 46.0% 45.6% 45.6% 44.0% 45.0% 45.5% -0.2%

K 42.7% 41.3% 40.1% 39.0% 38.9% 39.1% 39.2% 38.0% 35.6% 33.7% 34.1% -5.1%

MDLZ 37.4% 37.3% 36.8% 39.4% 39.7% 39.8% 40.1% 39.9% 40.4% 0.7%

KHC 31.8% 32.5% 32.1% 34.7% 38.8% 38.2% 34.8% 32.5% 32.3% -6.5%

SJM 34.9% 34.0% 36.3% 36.6% 37.3% 38.8% 38.0% 37.9% 38.1% 37.9% -1.0%

Average 37.7% 36.7% 35.8% 35.9% 35.5% 37.1% 38.1% 37.6% 36.2% 35.8% 35.8% -2.3%

7 January 2020


Figure 39: We Are Below Consensus EPS Estimates For 50% of the Names in Our Sector in Fiscal 2020

Source: FactSet, Company data, Credit Suisse estimates, as of 01/03/20

Figure 40: We Are Below Consensus Revenue Estimates For 40% of the Names in Our Sector in Fiscal 2020

Source: FactSet, Company data, Credit Suisse estimates as of 01/03/20

CompanyCS Growth

Estimate

Consensus

Growth

Estimate

CS Growth

Estimate

2019 2020 2019 2020 2019 2020 2019 2019 2020

Campbell $2.30 $2.54 $2.62 $2.53 -12.0% 0.1% -19.7% -8.7% 10.1%

Conagra $2.02 $2.08 $2.01 $2.09 0.5% -0.6% -4.3% -4.7% 2.9%

General Mills $3.22 $3.38 $3.22 $3.36 -0.1% 0.8% 3.4% 3.5% 5.2%

Hershey $5.74 $6.17 $5.74 $6.16 -0.1% 0.3% 7.0% 7.2% 7.6%

Kellogg $3.91 $3.97 $3.89 $4.02 0.7% -1.3% -9.9% -10.0% 1.3%

Mondelez $2.47 $2.67 $2.46 $2.65 0.4% 0.9% 1.9% 1.4% 8.1%

Kraft Heinz $2.82 $2.45 $2.81 $2.59 0.3% -5.3% -19.1% -20.3% -13.0%

B&G Foods $1.64 $1.56 $1.69 $1.74 -2.8% -10.7% -10.4% -8.8% -5.1%

McCormick $5.34 $5.78 $5.35 $5.57 -0.2% 3.7% 7.5% 7.7% 8.2%

Smucker $8.29 $8.07 $8.29 $8.15 0.0% -0.9% 4.1% 4.1% -2.6%

-1.3% -1.3% -3.9% -2.9% 2.3%

CS Estimates Consensus Estimates

Credit Suisse

Difference vs

Consensus

Company SalesCS Growth

Estimate

Consensus

Growth

Estimate

CS Growth

Estimate

Consensus

Growth

Estimate

2019 2020 2019 2020 2019 2020 2019 2019 2020 2020

Campbell $8,107 $8,132 $8,107 $8,133 0.0% 0.0% -6.7% -6.7% 0.3% 0.3%

Conagra $9,538 $10,632 $9,538 $10,716 0.0% -0.8% 20.2% 20.2% 11.5% 12.3%

General Mills $16,865 $17,184 $16,865 $17,213 0.0% -0.2% 7.1% 7.1% 1.9% 2.1%

Hershey $7,986 $8,224 $7,980 $8,193 0.1% 0.4% 2.5% 2.4% 3.0% 2.7%

Kellogg $13,528 $13,546 $13,524 $13,271 0.0% 2.1% -0.1% -0.2% 0.1% -1.9%

Mondelez $25,758 $26,551 $25,782 $26,481 -0.1% 0.3% -0.7% -0.6% 3.1% 2.7%

Kraft Heinz $25,079 $24,550 $25,054 $24,770 0.1% -0.9% -4.5% -4.6% -2.1% -1.1%

B&G Foods $1,655 $1,654 $1,662 $1,677 -0.4% -1.4% -2.7% -2.3% 0.0% 0.9%

McCormick $5,390 $5,478 $5,378 $5,518 0.2% -0.7% 1.6% -0.6% 1.6% 2.6%

Smucker $7,838 $7,591 $7,838 $7,588 0.0% 0.0% 6.5% 6.5% -3.1% -3.2%

Average 0.0% -0.1% 2.3% 2.1% 1.6% 1.7%

Credit Suisse

Difference vs

Consensus

Consensus EstimatesCS Estimates

7 January 2020


Figure 41: We Are Below Consensus EBIT Estimates for 50% of the Names in Our Sector for Fiscal 2020

Source: FactSet, Company data, Credit Suisse estimate as of 01/03/20

Figure 42: Credit Suisse vs. Consensus for 4Q19

Source: FactSet, Company data, Credit Suisse estimates as of 1/03/20

Company EBITCS Growth

Estimate

Consensus

Growth

Estimate

CS Growth

Estimate

Consensus

Growth

Estimate

2019 2020 2019 2020 2019 2020 2019 2019 2020 2020

Campbell $1,266 $1,301 $1,266 $1,294 0.0% 0.6% -10.1% -10.1% 2.8% 2.2%

Conagra $1,470 $1,714 $1,470 $1,745 0.0% -1.8% 23.4% 23.4% 16.6% 18.8%

General Mills $2,858 $2,954 $2,858 $2,941 0.0% 0.4% 5.8% 5.8% 3.3% 2.9%

Hershey $1,699 $1,798 $1,704 $1,798 -0.3% 0.0% 5.7% 6.0% 5.8% 5.5%

Kellogg $1,751 $1,737 $1,761 $1,791 -0.5% -3.0% -6.8% -6.3% -0.8% 1.7%

Mondelez $4,260 $4,452 $4,260 $4,555 0.0% -2.3% -1.4% -1.4% 4.5% 6.9%

Kraft Heinz $5,072 $4,779 $5,031 $4,822 0.8% -0.9% -16.6% -17.6% -5.8% -4.2%

B&G Foods $240 $236 $236 $247 2.0% -4.5% -5.7% -8.4% -1.8% 4.8%

McCormick $990 $1,060 $988 $1,047 0.2% 1.2% 6.5% 4.9% 7.0% 5.9%

Smucker $1,492 $1,419 $1,481 $1,427 0.8% -0.6% 4.2% 3.5% -4.9% -3.6%

Average 0.3% -1.1% 0.5% 0.0% 2.7% 4.1%

Consensus Estimates

Credit Suisse

Difference vs

Consensus

CS Estimates

Company Sales CS Estimate Consensus

Credit Suisse

Difference vs

Consensus Company EBIT CS Estimate Consensus

Credit Suisse

Difference vs

Consensus

HSY $2,068 $2,060 0.4% HSY $381 $386 -1.3%

K $3,173 $3,171 0.1% K $391 $403 -3.0%

MDLZ $6,803 $6,840 -0.5% MDLZ $1,093 $1,093 0.0%

KHC $6,638 $6,609 0.4% KHC $1,302 $1,290 0.9%

BGS-US $465 $473 -1.7% BGS-US $52 $54 -4.2%

MKC $1,527 $1,517 0.7% MKC $315 $313 0.6%

THS $1,156 $1,159 -0.3% THS $102 $104 -1.9%

Company EBITDA CS Estimate Consensus

Credit Suisse

Difference vs

Consensus Company EPS CS Estimate Consensus

Credit Suisse

Difference vs

Consensus

HSY $460 $461 -0.2% HSY $1.23 $1.24 -0.7%

K $552 $531 4.0% K $0.89 $0.86 3.3%

MDLZ $1,240 $1,318 -5.9% MDLZ $0.61 $0.60 1.8%

KHC $1,562 $1,560 0.1% KHC $0.68 $0.68 0.2%

BGS-US $67 $71 -6.3% BGS-US $0.28 $0.32 -11.7%

MKC $351 $352 -0.4% MKC $1.60 $1.61 -0.4%

THS $137 $155 -11.5% THS $1.08 $1.11 -2.7%

7 January 2020


Valuation

Valuation multiples in the staples sector tend to correlate strongly with organic revenue growth

rates. Over the past year, companies with the weakest sales trends (Smucker and Kraft Heinz)

experiencing significant multiple contraction versus their peers. McCormick and Church &

Dwight are fetching high valuation multiples for their growth.

Figure 43: Our Analysis Shows a Strong Correlation Between Forward P/E Valuation Multiples and Organic Revenue Growth Rates

for 2019 in the Consumer Staples Sector (R Squared Relationship of 0.61)

Source: FactSet, Organic sales growth estimates for calendar 2019. P/E multiples based on forward 12-month estimates as of 12/23/19

U.S. food trades at a discount to consumer staples peers, but we think it is justified due to the

stark difference in organic growth rates. Household products companies are growing at a 4-5%

rate, Beverage at 3.5% while Food is growing at only 1%.

BGS

CPB

CHD

CLX KO

CL

CAG

BN-FR

GIS

HSY

K

KMB

KHC

MKC

MDLZ

NESN-CHPEP

PG

SJM

UL

R² = 0.6101

10.0

15.0

20.0

25.0

30.0

35.0

-3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%

Forw

ard

P/E

Mu

ltip

le

Current FY Organic Growth Rate Estimate

7 January 2020


Figure 44: Packaged Food Companies are Growing at Only 1% Compared to

Household Products and Beverage Growth of 3.5%-4.5%

Source: Company data, Credit Suisse estimates, FactSet

Figure 45: Food Stocks Are Trading at a 31% Discount to Staples Peers Compared with a 17% Discount Average over the Past

Five Years

Source: FactSet, Credit Suisse estimates. Data as of 1/02/20

4.5%

5.2%

4.5%4.7%

3.8%

2.5%

3.5% 3.4%

1.1%0.9%

0.5%

1.1%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

1Q19 2Q19 3Q19 4Q19E

Household Products Beverages Packaged Food

10

12

14

16

18

20

22

24

26

NTM

P/E

Mu

ltip

le

Beverages Pkg Food Household Products

7 January 2020


Figure 46: Food Stocks Are Trading at an 8% Premium to the S&P 500 Compared to a 4% Premium over the Past 20 Years.

Source: FactSet, Company data, Credit Suisse estimates, as of 1/06/20

However, when we use valuation metrics that put greater emphasis on financial leverage and

cash flow return on capital, we find many of the food stocks just as expensive if not more

expensive than their historical averages.

Figure 47: Big Food’s (ex MKC) EV/EBITDA Multiple Average of 13.3x is 5% Higher than its 5-year Average, as of 1/02/19


Average P/E Multiples

CAG CPB GIS HSY K KHC MDLZ MKC SJM

Pkg

Food

ex MKC SPX

HPC -

Bev HPC PPC Bevg

Pkg Food

inc MKC

20 yr avg 14.9 16.4 16.5 20.7 16.7 17.0 20.0 19.3 16.0 17.0 16.4 19.3 19.8 13.0 18.7 17.5

10 yr avg 15.1 16.0 16.3 21.0 15.9 17.5 20.0 21.2 15.7 17.0 15.5 19.6 20.4 11.8 18.8 17.6

5 yr avg 16.8 17.2 17.3 21.3 16.8 19.1 20.2 24.2 16.0 18.1 17.1 22.0 23.0 10.4 21.1 18.8

Current 15.1 18.7 15.4 23.5 16.9 12.3 20.4 30.5 12.6 16.9 18.2 23.9 24.8 12.7 23.0 18.4

Food P/E Premium / (Discount) to Food Peers

CAG CPB GIS HSY K KHC MDLZ MKC SJM

Food /

SPX

Food /

HPC -

Bev

20 yr avg -12% -4% -3% 22% -2% NA NA 14% -6% 4% -12%

10 yr avg -11% -6% -4% 24% -7% 3% NA 24% -8% 10% -13%

5 yr avg -7% -5% -4% 18% -7% 6% 7% 34% -12% 6% -18%

Current -11% 11% -9% 39% 0% -27% 11% 66% -25% 8% -30%

Forward EV/EBITDA Multiples (based on consensus)

As of

1/1/19

As of

1/02/20

2011 2012 2013 2014 2015 2016 2017 2018 2019E 2019E

CAG 7.3 7.4 7.3 9.5 10.7 12.8 13.0 12.0 9.9 12.2

CPB 8.8 9.0 9.4 11.2 11.1 11.8 11.9 10.0 10.7 14.2

GIS 9.0 9.8 9.5 10.7 11.9 12.6 12.5 12.5 11.1 12.9

HSY 9.5 10.7 11.5 13.6 13.6 12.3 13.5 13.9 13.6 16.6

K 9.9 9.9 11.1 10.6 10.9 13.3 12.7 11.5 11.9 13.7

KHC 16.0 15.7 14.5 11.1 11.7

MDLZ 9.4 9.8 12.0 13.4 13.7 16.5 16.0 14.9 14.4 17.7

MKC 11.4 11.1 12.8 13.4 14.6 15.9 15.7 16.5 19.0 22.2

BGS 8.8 10.5 11.6 12.7 12.2 10.4 11.2 10.9 12.2 10.0

SJM 7.9 8.8 9.0 10.1 10.6 12.0 11.3 11.4 9.9 10.4

Average ex-MKC 8.8 9.5 10.2 11.5 11.8 13.1 13.1 12.4 11.6 13.3

7 January 2020


Figure 48: Short Interest in the Large Cap-Food Group Has Declined from a Peak of

7% of Shares Outstanding in Mid-2018 to 4.6% as of December 2019 but Remains

Above the Historical Average of 3.7%

Source: FactSet, Company data, Credit Suisse. Companies included in this calculation are KHC, MLDZ, GIS, K,

HSY, CAG, CPB, SJM

4.58

1.4

2.4

3.4

4.4

5.4

6.4

7.4

7 January 2020


Top Picks for 2020

Most Upside Potential

Mondelez (Outperform, $60 Target Price): After years of focus on cost controls that starved

the brands, the company has rejuvenated its revenue growth by decentralizing its decision

making and providing more resources to meet country-specific needs. Mondelez’ organic

growth rate has accelerated from 1.0% in 2017 to 3.5%+ in 2019 and is well on its way to 4-

5% in our view given the advantaged platform in developing markets (40% of sales) and its

strength in global snacks (Oreos, Cadbury, Milka, etc.). We believe the valuation multiple will re-

rate 2-3 turns higher as the higher growth rate puts the stock in the league of high quality,

multi-national peers like Pepsico, Nestle, and Unilever. We expect robust guidance for 2020 to

ease investors’ concerns about lack of operating leverage from its investments.

Tyson Foods (Outperform, $98 Target Price): Because of its leverage to higher protein

prices and global demand, Tyson is well-positioned to capitalize on African swine fever’s impact

on global meat supplies. With its pig herd down at least 40%, China will need to import more

meat from around the world to keep its domestic prices from getting out of control. The recent

thaw in U.S.-China trade relations represents another stepping stone to stronger U.S. meat

exports. As the export volume grows, we expect Tyson’s Pork and Chicken margins to return to

the high end of their normalized ranges. In this scenario, Tyson’s EPS can jump to over

$8.00/share, versus consensus’ FY21 EPS estimate of $7.43.

Kellogg (Outperform, $78 Target Price): We upgraded Kellogg to Outperform because we

believe that its portfolio changes and reinvestment spending over the past two years has set the

stage for sustainable revenue growth, margin expansion, and high single-digit EPS growth. We

expect the benefits of operating leverage to materialize in 2020 as the pace of reinvestment

slows, the temporary dilution from portfolio changes turns favorable, and the high-margin U.S.

cereal business stabilizes. Our view is that a good portion of the company problems in North

American cereal (19% of sales) are self-inflicted and that the business will improve considerably

in 2020 now that consumer trends in the cereal category have stabilized. With only 33% of sell-

side analysts recommending the stock, there is a lot of room for positive re-ratings and some

additional multiple expansion as well.

Nomad Foods (Outperform, $26 Target Price): We expect Nomad to generate significant

upside for shareholders similar to that of other U.S. M&A roll-ups. The core business is well on

track to maintain steady 2-3% organic growth because of its strong positioning in the attractive

plant-based frozen foods category. It is now in the process of rolling out a new Veggie Bowls

line under the Iglo brand into five European markets and launching Green Cuisine plant-based

protein substitutes in the UK. We have been positively surprised by management’s ability to

raise prices to offset commodity inflation in 2019 with minimal elasticity of demand. More

importantly, we expect the company to utilize the cash it raised from a recent equity offering to

make an accretive acquisition in the near-term. Prior acquisitions (Goodfella’s and Aunt

Bessie’s) both exceeded expectations. We see the EV/EBITDA valuation multiple (now at a

discount of 10% to its food peers) re-rating 1-2 turns higher once it consummates an

acquisition and as investors’ fears of a “hard Brexit” diminish.

Most Downside Risk

Campbell Soup (Underperform, $36 Target Price): We find it difficult to believe in

management’s three-year plan of generating 1-2% sales growth, 4-6% EBIT growth, and 7-

9% of EPS growth. While management has recognized that it needs to return the soup

category to growth after ten years of running it for profit, we fear that the size of the investment

will prove insufficient to fully address the structural challenges facing the Campbell brand.

Consumer preferences have shifted away from canned soups (which are roughly 30% of sales

and over 40% of profits) and V8 beverages in favor of fresher products with healthier, organic-

ingredient profiles. In addition we foresee integration issues on the horizon for the integration of

the Snyder’s-Lance business, which has a track record of losing pricing power with retailers and

7 January 2020


running into operational problems at its manufacturing facilities. Campbell’s poor track record of

acquisitions (which include Bolthouse Farms, Garden Fresh, and Erasco) increases the

integration risk.

B&G Foods (Underperform, $14 Target Price): We view B&G as ill-equipped to adjust to

the more demanding retail environment. Its traditional “manage for cash” playbook does not

appear robust enough to keep up with big competitors ramping up their investments and big

retailers’ demands for growth. For example, its most important growth vehicle, Green Giant

frozen vegetables, has lost shelf space to private label and Conagra’s Birds Eye this year and is

now in decline. Generally speaking, we struggle to understand how the company can execute

its acquisition strategy, maintain such a high dividend (payout ratio of 90%), and carry so much

debt on the balance sheet at the same time.

Kraft Heinz (Underperform, $27 Target Price): We expect a challenging road ahead for

Kraft Heinz as it tries to transform from what was originally conceived as a cost-cutting/M&A

vehicle into a company that can generate organic growth. Even if the new CEO Miguel Patricio

gets permission from the board to increase investment spending behind the antiquated brands

to do it, the progress undoubtedly will be slow. About 44% of Kraft Heinz’s U.S. retail portfolio

competes in commoditized categories (cheese, meats, coffee, and nuts) where the company

has been losing share to private label or more on-trend brands.

Near-term, we see downside risk to the stock from another dividend cut. If the board keeps the

dividend at the current level, the debt rating agencies are threatening to cut the company’s

rating below investment grade unless EBITDA shows signs of stabilization. This would increase

the company’s cost of capital, increase the risk profile of the business, and pose as a significant

obstacle to the company’s vision for further M&A.

7 January 2020


Large-Cap Food Bull and Bear Cases

Campbell (Underperform Rating, $43 Target Price)

Our $43/share target price assumes a 16x P/E multiple against our forward 12-month forward

EPS estimate. This represents a 4% discount to packaged foods peers compared to a 6%

discount historically. An unexpectedly positive response in soup from management’s turnaround

efforts represents the biggest upside risk to our rating and target price.

Bull-Case

Portfolio of Big Important Brands with Operating Scale

Campbell maintains significant leadership and scale in important categories such as soup,

biscuits, and vegetable juice with iconic brands including Campbell's, Snyder’s-Lance,

Pepperidge Farm, and V8. The Dorrance family still controls the board and continues to operate

with a long-term perspective. This ought to provide the new CEO, Mark Clouse, with a long

runway to overhaul Campbell’s brands.

Opportunity for Synergies to Improve Margins

Snyder’s-Lance business’ 9% EBIT margin is substantially lower than Campbell’s 16% base

business margin. Margins could move much higher if Campbell’s management were to fix

Snyder’s-Lance's underlying supply chain problems, improve overhead efficiency and perhaps

sell the low-margin snack nuts business.

At its investor day, management outlined its plans to generate an additional $315M in synergies

out of its planned $850M (ex C-Fresh) by FY22, with over 60% from Snyder’s-Lance and the

rest from the enterprise cost saving program (ECSP). The company is ahead of plan in FY 20

having delivered $45M in 1Q20 and raising its FY 20 guidance to $140-$150M (from $140M).

ECSP will derive $50M of its savings network optimization, which includes the closure of the

Toronto soup manufacturing plant as production moves to the US.

Management indicated that Snyder’s-Lance synergies will derive from (i) Manufacturing; (ii)

Warehouse & Distribution; (iii) Procurement and (iv) Sales Initiatives. We estimate the timeline

for incremental savings per year as: (1) FY20: $140 - $150M; (2) FY21: $80M to $100M and

(3) FY22: $75M - $85M.

Management Will Be Investing $70M over 3yrs to Stabilize Soup

After more than three years of large soup sales declines, management has underlined soup

stabilization as a ‘top priority.’ Instead of running it for cash as it did over the last 10 years,

management plans to invest $70M into the category over the next 3-yrs. In order of magnitude,

this investment includes (1) a 2-point expansion of marketing expenses, (2) investment in

product quality; and (3) investment in price. CEO Clouse stated that retailers have responded

positively to Campbell’s intentions to return the category to growth. This might be a sign that

retailers will give more leeway as it works to restore the business and develops new product

innovations.

Potential for Positive Earnings Revisions

Campbell stock has gained favor with investors because CEO Mark Clouse and the

management team have done a good job of setting more reasonable expectations for growth

and providing sufficient cushion for positive earnings revisions. Since Clouse joined the company

in January 2019, the company has beaten quarterly estimates four quarters in a row.

The board, which is still controlled by the Dorrance family, might be learning to take a more

shareholder-friendly approach as well. Before Clouse joined the company, the interim CEO

lowered the earnings base and the margin structure for the Meals and Beverage division to a

significant degree. This set the table for Clouse to return the company to re-establish a pattern

of beating expectations in FY 19 even though the company’s profits still declined. Following the

conclusion of activist investor Third Point’s proxy battle with Campbell in 2018, the board has

made some positive changes to its structure, in our view.

7 January 2020


Bear Case

Soup Investment of $70M is Appears Too Small

Consumer preference has shifted away from canned soups (which are roughly 30% of sales

and over 40% of profits) in favor of fresher soups and healthier, organic-ingredient profiles.

Campbell’s repeated attempts to introduce a convincing organic version of its Campbell branded

soup is a good example of how difficult it is for heritage brands to adapt to changing consumer

preferences. Consumers still eat soup but they have shifted to higher quality foodservice

formats and paper packaging. Within canned soup, we believe private label has narrowed the

quality gap with the Campbell’s brand. Frankly, we were surprised to see that new management

did not spend more time addressing this issue or providing more data that measures consumers’

perception of Campbell’s taste or quality.

Unclear How Patient Retailers Will Be with Soup Turnaround

In our view, there is still substantial risk that retailers will reduce the enormous shelf space they

dedicate to canned soup (why does it need 70-80 SKUs?) in favor of more on-trend offerings.

In the near-term, the company does not appear to have much excitement planned for fiscal

2020. Expansion of bone broth and soup-to-go offerings (which has been around for years) is

not enough to move the needle, in our view. Recall that Walmart severely penalized Campbell in

2017 – 2018 when Campbell refused to provide sufficient promotional support.

Integration Risk Is Higher than the Street Realizes

In our December 2018 report, we noted that Campbell has the weakest M&A track record

relative to its peers with only 9% of acquisitions over the past 6-yrs meeting or exceeding

expectations. Since Snyder’s-Lance arrived with pre-existing problems (including poor capacity

utilization and ineffective marketing investment), we believe this integration will pose an even

bigger challenge than what Campbell has faced in the past.

Campbell has chosen not to provide pro forma sales or profit trends for Snyder’s-Lance. This

makes it difficult to fully evaluate Campbell’s progress with the business. For example,

management stated it achieved its target for year one and that it is on track for its three-year

savings plan, but recall that the company lowered its Snyder’s-Lance target only two months

after announcing the transaction in December 2017 and then lowered its sales target again in

May 2018 due to unfavorable price contracts with customers.

Additionally, we foresee significant cost, legal challenges, cultural risk, and execution risk in the

future for this integration. If Campbell tries to consolidate its three DSD networks, it will need to

break the contracts of many of the independent Pepperidge Farm route operators and buy out

the routes. The Pepperidge Farm operators will resist these efforts because they have held

contracts for their routes for 20-30 years.

7 January 2020


Figure 49: We Estimate That Roughly 45% of Campbell’s Portfolio Is Structurally Challenged ($M)

Source: Company data, Credit Suisse estimates. Nielsen xAOC+C

Conagra Brands (Neutral Rating, $32 Target Price)

Our $32/share target price is based on a 14.4x P/E multiple against our FY 21 estimate of

$2.22. This assumes a 15% discount to closest food peers, which is significantly higher than its

Good 2015 2016 2017 2018 52 wks

% of Total

Sales 2019 3yr CAGR 2019 Growth

Goldfish 784 832 872 873 926 10.2% 3.6% 6.2%

Prego 465 502 522 519 532 5.9% 2.0% 2.5%

Lance 417 448 464 486 496 5.5% 3.4% 2.1%

Other Brands 195 332 354 351 360 4.0% 2.7% 2.4%

Cape Cod 246 259 271 277 281 3.1% 2.7% 1.4%

Snack Factory 193 210 223 222 229 2.5% 3.0% 3.6%

Kettle 180 191 202 209 205 2.3% 2.5% -2.2%

Pacific Foods 113 125 135 146 135 1.5% 2.5% -8.2%

Late July 29 42 58 80 91 1.0% 30.1% 15.8%

SubTotal 2,622 2,940 3,100 3,162 3,255 35.8% 3.5% 2.9%

Stable 2015 2016 2017 2018 52 wks

% of Total


Pepperidge Farm Bread 950 933 922 942 974 10.7% 1.4% 3.6%

Snyder's of Hanover 499 483 505 484 470 5.2% -0.9% -2.8%

Spaghettios 128 128 135 134 133 1.5% 1.3% -1.0%

Emerald 127 124 116 118 124 1.4% -0.2% 4.9%

Jays 65 65 63 63 64 0.7% -0.6% 1.9%

SubTotal 1,769 1,735 1,741 1,742 1,766 19.4% 0.6% 1.5%

Challenged 2015 2016 2017 2018 52 wks

% of Total


Campbell's Soups 1,475 1,320 1,272 1,184 1,165 12.8% -4.1% -2.3%

V8 852 789 741 718 688 7.6% -4.4% -4.2%

Chunky Soup 537 534 538 523 511 5.6% -1.5% -3.0%

Swanson 517 527 502 507 510 5.6% -1.1% 0.5%

Campbell's Other Non-Soup Brands 345 342 339 328 307 3.4% -3.5% -6.7%

Pepperidge Farm Cookies 278 280 273 280 270 3.0% -1.2% -3.4%

Pace 255 266 256 257 256 2.8% -1.2% -0.2%

Pop Secret 241 212 189 169 169 1.9% -7.2% 0.2%

Plum 118 138 128 126 115 1.3% -5.9% -8.9%

Tom's Snacks 78 84 81 79 75 0.8% -3.5% -5.1%

SubTotal 4,696 4,491 4,319 4,172 4,068 44.8% -3.2% -2.8%

Total Campbell Sales 9,088 9,166 9,160 9,076 9,089 100.0% -0.3% 0.0%

7 January 2020


0% 5-year average. Continued improvement in the company’s revenue growth represents the

biggest upside risk to our target. Inability to de deliver synergies as planned poses the biggest

downside risk to due to the high degree of financial leverage.

Bull-Case

Strong Management Track Record, Prior to Pinnacle Acquisition

After assuming the CEO role in 2015, Sean Connolly led a highly impressive business

turnaround and cultural transformation by moving Conagra’s headquarters out of Omaha to

Chicago, selling or spinning off noncore businesses, and establishing a healthier base of sales

by walking away from unprofitable discounting. Resonant product innovation catering to

demographic trends, premium-ization, revamped packaging, and on trend ingredient usage led

to strong consumption at a time when the broader packaged food industry was struggling.

These initiatives gave Conagra “permission” to sell more at a full price and escape the

uneconomic pattern of deep discounts to drive volume.

Leadership and Scale in Frozen Foods

With the Pinnacle Foods acquisition, Conagra has become the number-two player in the frozen

market, similar in size to market leader Nestle. It has an excellent opportunity to capitalize on

Nestle’s recent pullbacks in the U.S. frozen aisle and Kraft Heinz’s operational distractions. For

example, Nestle recently exited its DSD network in the frozen aisle and sold its ice cream

business. Retailers theoretically should give Conagra more favorable merchandising support at

the expense of these two competitors.

Additionally, the Conagra management team has also demonstrated to retailers that it has the

ability to turn around antiquated brands and drive profitable growth. For example, management

successfully refreshed Healthy Choice, Banquet by refreshing the package, adding higher

quality ingredients and improved marketing. This should make retailers more willing to give

Conagra some wiggle room as it rebuilds Pinnacle’s product line up.

Better-than-Expected Distribution Trends

In late October, we were feeling very cautious about Conagra’s future prospects in the frozen

aisle at Walmart because we found that Walmart had accepted only 33-40% of Conagra’s new

items as part of a shelf reset and that Conagra’s Birds Eye vegetables had lost shelf space to

private label. That was the case at the time, but our recent store checks and the company’s

strong 2Q results suggest that Conagra may have picked up enough new facings on its top

selling items to offset the distribution it lost or failed to achieve. On its last earnings call,

management provided sufficient evidence regarding Birds Eye’s overall distribution trends (now

flat vs. prior year compared to -10% last quarter) and frozen meals distribution (up 1.2 share

points, from 0.6 in 4Q) to assuage some of our concerns. In addition, our recent store checks

at Walmart, although limited in scope, did not find evidence that Conagra’s overall “facings” had

declined following the reset.

Visibility Improving, Synergies Revising Higher

Management’s conviction that its organic sales growth will improve sequentially in 3Q compared

to 2Q was surprising and hard to refute: 1) in stark contrast to the pull back on Pinnacle

merchandising last year, new product activity for the brands in 3Q is expected to accelerate; 2)

Hunt’s and Chef sales are improving; 3) the headwind from retailer investment spending is

dissipating; and 4) the core Conagra business is more likely to have a “normal” comparison.

Management also raised its synergy target by $20M, thus providing more flexibility for

reinvestment.

Opportunity for Value Creation Through Divestitures

Conagra Brands holds a valuation allowance of about $1 billion for a tax asset that was

generated from the loss realized on the sale of its Private Brands operations. This will enable

the company to divest structurally declining brands or perhaps exit its stake in the Ardent Mills

7 January 2020


joint venture in a tax-free manner. It has already announced the divestitures of Wesson, Gelit,

the DSD snacks business at Pinnacle, and private label peanut butter.

Bear Case

Difficult to Manage a Highly Fragmented Portfolio with So Many Off-Trend Brands

A significant percentage of Conagra’s highly fragmented portfolio of 100 brands is either off-

trend with consumers (like Chef Boyardee, Hunts, and Orville Redenbacher) or targeted to

consumers with low purchasing power (like Banquet).

Given these vulnerabilities, there is significant risk that the challenges facing Pinnacle will

distract management from the core business and cause execution missteps. These concerns

played out in the 4Q19 and 1Q20 sales miss relating to Marie Callender’s, Duke’s, P.F.

Changs, and Hunts brands. Management called these issues “transitional,” but it might be an

early indication of more challenges in the core business to come. If a “good” business like

Pinnacle can turn into a “bad” one so quickly in today’s challenging business environment (as

management found soon after closing the transaction), why should we feel comfortable that the

core Conagra business won’t experience the same problem?

Pinnacle in Worse Shape than Conagra Expected

Conagra stock fell significantly in December 2018 after management-slashed expectations for

Pinnacle’s operating margin by about 350 basis points to 14.6-14.9% and stated sales will

likely decline 5% in 2019. This equates to a reduction of about $120M in profit. CEO Sean

Connolly blamed the reductions on a litany of product innovation missteps and unprofitable trade

promotions by the prior management team. Whether intended or not, the severity of the cut

sent a signal to investors that management walked into a bad deal and overpaid, even though it

had plenty of time to evaluate the risks and rewards of pursuing the deal. It is taking a lot of

work and time to regain investor confidence in the transaction.

Despite the major reduction to Pinnacle’s year one expectations, management told the Street

that it can still achieve its three-year financial targets for the Pinnacle acquisition. It has now

steadily increased expected synergies from 8% of Pinnacle’s sales ($215M) to 9% and then,

most recently, to over 10% ($305M). Management said it would reinvest the most recent

increase back in the business (about $20M), but by our math the majority of the savings is

expected to drop directly to the bottom line. Also, management said that it intends to shave its

CapEx spending to maximize cash flow for debt reduction.

Even investors who have a positive opinion of CEO Connolly felt whipsawed by his surprisingly

negative commentary regarding the condition of Pinnacle’s business. However, as shown in the

chart below, they also took some comfort knowing that Connolly has a track record for reducing

expectations after stepping in to take control of businesses and then handily beating those

expectations. This was the case in his first full year as CEO of Conagra in fiscal 2017 and his

first full year as CEO of Hillshire Brands in fiscal 2013. We attribute this pattern to the

importance Connolly puts on beating expectations and his willingness to make radical changes

to companies that do not fit his operating model.

7 January 2020


Figure 50: CEO Sean Connolly Introduced a Low Guidance Range in His First Years at

Conagra and Hillshire Brands and then Beat the Range


In this environment, it sounds a bit scary when a business with declining sales responds by

stepping on the cost-cutting accelerator instead of reinvesting in the business. Recall that

Pinnacle was already operating in a highly lean manner when Conagra bought it and that it had

cut SG&A by almost $80M since 2016. As a result, we worry that Conagra will need to reinvest

more of the synergies than it expects to stabilize Pinnacle’s declines and compete with B&G

and Nestle in the frozen aisle.

Category “Captaincy” Has Not Provided as Much Leverage as Expected

One of the main benefits of the Pinnacle acquisition was that it was supposed to make Conagra

the leader in frozen meals and vegetables and as such provide negotiating leverage with its

retailer customers. However, as Walmart has taken more control over its category management

decisions, Conagra’s influence appears to have waned. We find it very curious that Walmart

rejected most of Conagra’s new product recommendations and increased space for private label

vegetables during it October shelf reset. Conagra didn’t lose any shelf space, but it certainly

didn’t gain any either. We believe these decisions were part of a broader strategy at Walmart to

reduce SKU proliferation and improve e-commerce execution at its brick-and-mortar stores.

Whatever the reason, Walmart’s initial resistance to Conagra’s new product recommendations

and its commitment to private label suggest to us that Conagra’s ability to control its own

destiny in the frozen aisle is not what it expected.

Hillshire FY12 FY13* FY14

Actual EPS 1.55$ 1.72$ 1.72$

CS Est. 1.55$ 1.52$ 1.67$

Positive Revision 13% 3%

*Management guidance of $1.40-$1.55 for FY 13 announced August 2012 was well below consensus

Conagra FY15 FY16 FY17 FY 18

Actual EPS 2.18$ 1.30$ 1.74$ 2.11$

CS Est as of 11/15/16 1.67$ 1.84$

4% 15%

Pinnacle

Trailing 12

months prior

to acquisition

First 12 months

(estimate)

FY 22

(implied

estimate)

Sales ($M) 3,174 2,886 3,000

Operating Profit 584 457 700

OP Margin 18% 16% 23%

7 January 2020


Figure 51: We Estimate That Roughly 45% of Conagra’s Portfolio Is Structurally Challenged ($M)

Source: Company data, Credit Suisse estimates, Nielsen xAOC+C

Good 2014 2015 2016 2017 2018

L52

Week

% of Total

Sales

3-Yr

CAGR

52wk

Growth

Slim Jim 531 580 577 552 562 595 4.8% 1.1% 6.2%

Healthy Choice 456 421 401 417 502 545 4.3% 10.8% 9.8%

Reddi Wip 228 255 280 291 291 297 2.5% 2.0% 2.2%

P.F. Chang's 128 156 149 154 174 194 1.5% 9.0% 12.1%

Angie's 47 61 72 100 123 138 1.1% 24.2% 13.8%

Gardein 41 54 69 92 118 124 1.0% 21.7% 5.1%

EVOL. 46 68 78 90 84 73 0.7% -2.6% -14.4%

BIGS 38 48 58 64 68 72 0.6% 7.9% 7.8%

Earth Balance 41 49 51 55 60 60 0.5% 5.3% -0.8%

Sub Total 1,558 1,692 1,735 1,816 1,982 2,097 17.0% 6.5% 6.4%

Stable 2014 2015 2016 2017 2018

L52

Week

% of Total

Sales

3-Yr

CAGR

52wk

Growth

Birds Eye 1,031 1,116 1,198 1,294 1,361 1,333 11.7% 3.6% -2.0%

Marie Callender's 1,002 1,005 1,008 1,010 1,022 1,013 8.8% 0.2% -1.3%

Banquet 1,064 964 818 763 827 869 7.1% 2.0% 6.0%

Vlasic 290 297 294 290 297 299 2.5% 0.5% 0.7%

Hungry-Man 212 207 217 208 202 191 1.7% -4.1% -5.5%

PAM 173 185 188 184 187 188 1.6% 0.1% 1.0%

Bertolli 250 217 196 183 167 160 1.4% -6.5% -4.8%

Swiss Miss 171 153 145 138 151 153 1.3% 1.7% 2.4%

Act II 102 106 103 101 110 123 0.9% 6.1% 12.9%

Manwich 91 86 84 80 82 84 0.7% -0.2% 2.8%

Sub Total 4,387 4,335 4,251 4,251 4,405 4,414 37.7% 1.3% 0.3%

Challenged 2014 2015 2016 2017 2018

L52

Week

% of Total

Sales

3-Yr

CAGR

52wk

Growth

Other Brands 2,217 1,852 1,818 1,718 1,677 1,637 14.4% -3.4% -2.7%

Hunt's 652 645 621 567 558 514 4.8% -6.1% -8.5%

Chef Boyardee 520 519 480 461 462 440 4.0% -2.8% -4.8%

Orville Redenbacher's 316 292 278 260 271 271 2.3% -0.8% 0.5%

Snack Pack 249 243 230 221 220 231 1.9% 0.2% 5.2%

Odom's Tennessee Pride 221 234 228 221 216 212 1.9% -2.4% -3.0%

Herbrew National 230 219 217 205 202 192 1.7% -3.9% -4.9%

Wish-Bone 221 212 212 196 170 158 1.5% -9.3% -8.5%

Blue Bonnet 195 195 189 180 166 161 1.4% -5.2% -3.5%

David 182 175 160 146 139 144 1.2% -3.5% 3.7%

Peter Pan 187 178 176 166 157 139 1.3% -7.6% -11.8%

UDI's 142 173 176 161 152 128 1.3% -10.2% -16.8%

Smart Balance 230 182 151 134 124 115 1.1% -8.8% -7.8%

Libby's 106 107 101 97 99 100 0.9% -0.4% 0.5%

Lender's 92 89 84 81 81 77 0.7% -3.0% -5.3%

Mrs. Butter-Worth's 81 81 76 74 73 69 0.6% -3.0% -6.2%

La Choy 84 82 82 76 73 68 0.6% -6.1% -6.7%

Egg Beaters 125 132 120 92 77 64 0.7% -18.7% -17.8%

Glutino 72 68 71 67 64 50 0.5% -10.7% -20.9%

Duncan Hines 336 312 296 330 308 267 2.6% -3.4% -14.1%

Sub Total 6,459 5,989 5,764 5,453 5,289 5,035 45.3% -4.4% -5.1%

Total Conagra 12,404 12,017 11,750 11,520 11,676 11,547 100.0% -1.0% -1.1%

7 January 2020


General Mills (Neutral Rating, $56 Target Price)

Our $56/share price target implies a 15.8x multiple on our forward 12-month EPS estimate,

which is a 3% discount to its peers, in line with its 5-yr average. Dilutive divestitures or changes

in consumer sentiment for Blue Buffalo represent the biggest risk to our target price.

Bull-Case

Strong Portfolio of Leading Brands

With $17 billion in sales and historically strong growth rates, General Mills has leading positions

in the U.S. and in global cereal, yogurt, and snack bar categories. Its stable of eight $1 billion

brands includes Cheerios, Nature Valley, Yoplait, Pillsbury, Blue Buffalo, Betty Crocker,

Haagen Dazs (international license only), and Old El Paso. It also has a long-standing joint

venture with Nestle in global cereal. After doing a good job of expanding into the natural and

organic products category by acquiring Annie’s, Epic, and Larabar, it has now diversified into

pet food by buying Blue Buffalo, a leading premium dog food brand.

It describes cereal and pet as its “highest return” categories (15% and 8% of sales), yogurt as a

high priority category (12% of sales and declining) and snacks, ice cream, Old El Paso meals,

and natural & organic (25%) as its “accelerate for growth” categories.

Sales Trends in North America Stabilized

We think the company is taking a more realistic approach to its investment and growth

expectations for North America Retail. After several years of decline, the North America Retail

business (80% of sales) is finally showing signs of stabilization with organic sales flat in the

1H20. The Cereal division has gained share owing to effective product innovation and, to some

degree, the struggles at its biggest competitor Kellogg. Old El Paso, Pillsbury, and Progresso all

had a strong first half while declines in Fiber One and Nature Valley began to diminish.

Management runs this division with the expectation that it can keep pace with category growth,

which is about 1%.

Margins are expanding again due to the mix towards cereal and the effective use of Holistic

Margin Management practices. It is also possible that the company’s increased investment in

revenue management, data analytics, and e-commerce (which largely falls under the heading of

unallocated corporate expense) is having a positive impact on this division’s operating

effectiveness.

Successful Expansion of Blue Brand Into Mass

Since the acquisition, General Mills has done a good job of overseeing Blue Buffalo’s broader

expansion into the broader FDM (food, drug, and mass) channel, especially Walmart. Overall

retail sales are growing at a low double-digit rate, with the gains in FDM more than offsetting

the declines in Blue’s heritage pet specialty channel. This includes a 45% growth rate at FDM

retailers where the brand has been in distribution for over 12 months (meaning excluding

Walmart). Household penetration (now at 9.8%) has increased at a pace of 1.8% per year over

the past two years compared to only 0.7% when it was limited to pet specialty retailers. We

estimate that Blue’s sales at Walmart will generate $140M on an annual basis, including an

outsized fiscal 4Q19 of $50M to fill Walmart’s shelves and distribution centers

Management expects General Mills’ margins to move higher owing to a reduction in Buffalo co-

packing as it opens new production facilities and realizes its $50M of planned synergies from

freight and ingredient purchasing.

Bear Case

Risks to FY20 Forecast is Rising

While other food stocks appear poised for positive earnings revisions, we think GIS is heading in

the opposite direction. The International and Convenience & Food Service divisions both missed

7 January 2020


expectations in 1Q20 and U.S. yogurt is now behind its plan as well. In addition, the company’s

Snack division was still in negative territory in 2Q and the Pet Food division is now facing a

potential shift in consumer attitudes toward grain-free formulations. We think General Mills is a

higher quality company than its peers with higher quality earnings, but we don’t think the stock

can move higher when earnings estimates go lower.

Slow-Down in Grain-Free Pet Food

Management said that its Blue Buffalo brand (up low DD% at retail) has not experienced any

negative impact from the FDA’s recent investigations into a possible connection between grain-

free pet diets and canine dilated cardiomyopathy (DCM). However, it acknowledged that the

growth rate of the sub-category has slowed. The FDA research falls short of drawing a causal

effect, but a change in consumer sentiment presents a considerable risk to Blue’s growth rate

longer-term. Since its inception, the Blue brand has built its positioning on the benefits of grain-

free formulations and actively compared its ingredient statements to grain-based competitors in

its advertising. Uncertainties regarding this issue have created a bigger overhang on the stock

than we expected.

Blue Buffalo’s Expansion into Mass Poses Risks

Management has clear visibility into near-term distribution gains at Walmart and other mass

retailers. However, in the longer term, we question whether Blue’s expansion into wet dog food

and pet snacks will be as successful as management expects. These sub-categories tend to be

less “sticky” in terms of generating repeat purchase and it is more difficult to create

differentiated products. Consumers tend to be less brand loyal in these subcategories than they

are in dry pet food, which is Blue’s core. They may give Blue’s offerings a try, but the repeat

rates will be lower than normal.

We are also concerned that Blue’s sales in the Specialty channel (approximately 45% of sales)

will continue to decline by double digits owing to a backlash from retail operators in the channel

and cannibalization of consumer demand. Management insists that the growth in FDM will far

outweigh the sales it loses in Specialty, but this should become very hard to do once the

company laps the initial Walmart distribution gains. Blue launched a new brand called Carnivora

into the Specialty channel to stem the declines, but it has not yet proven sufficient.

Potential for More Dilutive Divestitures

General Mills aims to divest 5% worth of company sales as it reshapes the portfolio to return to

growth. We would not be surprised if management decided to sell its Progresso or Hamburger

Helper brands. We are concerned that earnings dilution from a divestiture (similar to the Green

Giant divestiture in 2015) would hurt the stock and raise more questions about management’s

capital allocation choices. Paying 25x EBITDA to enter the pet food category with no operating

experience while divesting stable cash flow generators for 10x EBITDA considerably increases

the risk profile of the portfolio.

7 January 2020


Figure 52: We Estimate That Roughly 25% of General Mills' Portfolio Is Structurally Challenged ($M)


Hershey (Neutral Rating, $155 Target Price)

Valuation

Our $155/share 12-month target price is based on a 24x P/E multiple against our

forward estimate, in-line with the stock’s current P/E valuation. While this multiple is at

the very high end of its historical range, we think the strong franchise value of the

Good 2015 2016 2017 2018 L52 Wks

% of Tota l

2019 Sales

3-Yr

CAGR

L52 Wks

Growth

Blue Buffalo 0 2 63 283 579 4.6% 604% 115%

Old El Paso 481 490 505 532 559 4.5% 5% 6%

Annie's 232 312 354 352 343 2.7% 3% -2%

Larabar 86 123 164 191 180 1.4% 14% -5%

Gardetto's 108 115 116 115 121 1.0% 2% 6%

Mott's Fruit Snacks 69 78 96 102 104 0.8% 10% 2%

Fruit Gushers 85 76 79 91 102 0.8% 10% 14%

Epic 2 8 17 30 45 0.4% 81% 59%

Subtotal 1,063 1,203 1,394 1,696 2,034 16.3% 19% 45%

Stable 2015 2016 2017 2018 L52 Wks

% of Tota l

2019 Sales

3-Yr

CAGR

L52 Wks

Growth

Breakfast Cereal 2,977 2,902 2,819 2,776 2,856 22.9% -1% 3%

Pillsbury 1,754 1,673 1,582 1,611 1,601 12.8% -1% 0%

Nature Valley 981 980 1,036 1,014 952 7.6% -1% -6%

Totino's 946 905 906 959 974 7.8% 2% 2%

Chex Mix 376 343 331 329 336 2.7% -1% 3%

Gold Medal 166 150 149 152 154 1.2% 1% 3%

Betty Crocker Super Moist 141 146 143 144 150 1.2% 1% 5%

Other General Mills 129 98 94 107 113 0.9% 5% 6%

Fruit Roll-Ups 67 67 71 71 70 0.6% 1% -1%

Fruit By The Foot 39 46 52 53 52 0.4% 4% -2%

Muir Glen 47 49 45 45 45 0.4% -3% 0%

Subtotal 7,625 7,359 7,227 7,261 7,302 58.5% 0% 155%

Challenged 2015 2016 2017 2018 L52 Wks

% of Tota l

2019 Sales

3-Yr

CAGR

L52 Wks

Growth

Yoplait 1,773 1,475 1,200 1,176 1,153 9.2% -8% -2%

Progresso 826 769 722 735 733 5.9% -2% -1%

Other Betty Crocker 881 773 658 627 623 5.0% -7% -1%

Hamburger Helper 202 198 195 177 173 1.4% -4% -3%

Fiber One 361 301 214 171 125 1.0% -25% -27%

Cascadian Farm 157 146 131 126 110 0.9% -9% -12%

Suddenly Salad 78 84 75 72 79 0.6% -2% 10%

Betty Crocker Rich & Creamy 57 56 55 53 55 0.4% 0% 5%

Mountain High 43 44 41 36 34 0.3% -9% -7%

Betty Crocker Delights 18 24 36 43 28 0.2% 6% -33%

Bisquick 21 19 18 17 18 0.1% -1% 11%

Liberte 24 20 14 15 13 0.1% -13% -11%

Subtotal 4,442 3,909 3,358 3,247 3,144 25.2% -7% -76%

Total 13,129 12,471 11,979 12,203 12,480 100.0% 0% -29%

7 January 2020


company and the likelihood of positive earnings revisions justifies the premium at this

time. Failure to return core confectionery sales to sustainable growth represents the

biggest risk to our target price.

Bull-Case

Market Leadership in an Advantaged Category

Confectionery remains a highly advantaged category in the packaged food industry. Per the

National Confectionery Association, it is the fourth biggest category in stores and among the 10

most profitable. Candy has high household penetration, caters to all ages and demographics,

and offers strong profit margins to the retailer. Consumers have an emotional attachment to

chocolate in particular that runs deeper than just about every processed category we can think

of.

Hershey is the market leader in the space and has the luxury of operating an enormously

popular brand. Research indicates it ranks in the top 10 of the most popular brands across the

entire consumer goods spectrum (not just food) and that it caters to all ages. Consumers

associate it with positive feelings and fun.

Figure 53: Hershey’s Brand Power Is an Important Factor in the Value of the Stock

Source: Tenet Partners, CoreBrand, Smarty Pants, Credit Suisse

Reinvestment Spending Has Improved Topline Growth

After years a couple of years of spending declines, Hershey is reinvesting in advertising to drive

sales growth. This included an 11% cut to spending in 2018 when it consolidated advertising

agencies and developed in-house media production capabilities. These investments boosted

Hershey’ confectionery growth rate back to 2.2% in 3Q and resulted in 17 bps of share gains.

The company’s organic growth rate has improved to 2.0% this year compared to 0.3% for the

past two years. Capacity expansion for the Reese’s and Kit Kat brands has enabled more

innovation flexibility, such as Reese’s Thins and Kit Kat Duos. We view the higher spending as

highly important to an impulse category like confectionery and as another sign of management’s

confidence in its business.

Resurgence of Pricing Power

Unlike most of the food industry, Hershey and Mars essentially enjoy a duopoly in mass

chocolate with practically no private label threat. In July 2018, HSY announced price increases

that equated to a weighted average of 2.5% consisting of higher rates for freight, a packaging

change for bags, and higher prices for King Size bars. Then in July 2019, it announced another

price increase equating to 2.3% consisting of an 8% increase on single-serve products, which

are 33% of the portfolio). Because the second price encompassed products with less seasonal

price protections, we expect to see 3-4% higher pricing in 1Q20 from a modest overlap of the

Top 100 Most Powerful

Brands in 2019 Rank

Top 50 Brands Among Kids

Ages 6-12 in 2019 Rank

Parents Most Loved

Brands in 2019 Rank

Coca-Cola 1 Youtube 1 Amazon 1

Apple 2 Oreo 2 Crayola 2

Walt Disney 3 M&M's 3 Netflix 3

Bayer 4 Hershey 4 Lion King 4

Microsoft 5 Doritos 5 Hershey 5

Pepsico 6 Chips Ahoy 6 Google 6

Johnson & Johnson 7 Netflix 7 Oreo 7

Google 8 Cheetos 8 Reese's 8

Hershey 9 Lays 9 M&M's 9

American Express 10 Goldfish 10 Toy Story 10

7 January 2020


two price actions. Management said that this will consist of one-third of the 2018 price increase

and perhaps 1.0% from the 2019 price increases.

Figure 54: Expected Price Increases

Source: Company data, Credit Suisse estimates. 3Q19 negatively offset by price protection credits.

E-Commerce Risk, Not as Bad as Feared

With the growth of e-commerce grocery delivery versus in-store, we initially believed that the

shift in shopping patterns to more convenient methods such as online and click-and-collect will

gradually reduce the number of impulse purchase occasions for confectionery products

merchandised at traditional checkout aisles. However, the company’s strong e-commerce

trends have alleviated our concerns. After years of underinvestment, the company has hired

talented executives from the outside to develop a strong e-commerce platform and integrate it

into the business units. Hershey’s e-commerce sales grew 50% in 3Q and its market share

over other confectionery companies grew 610 bps.

Insights we picked up from and our visit to the Groceryshop Expo and the National Association

of Convenience Stores Trade Expo also supported a more constructive view on Hershey. Brick-

and-mortar stores has actually increased y/y even though e-commerce continues to grow. This

is a big positive for impulse purchase categories like Hershey’s. A big reason for the increase is

that click-and-collect customers like to park their cars and enter the stores to do additional

shopping. Hershey has leveraged this insight to persuade retailers to increase candy placement

locations so as not to lose a potential sale.

Bear Case

Valuation Is Stretched

The stock is trading at all-time highs and is up 58% over the past year. Over the past 32 years

(using monthly data), it has only traded at this this level 5% of the time. Its forward P/E is

trading at 25.5x which is a 23% premium to its 10 and 20 year average (20.7x and 20.6x)

Price Increases May Not Be as Robust as Expected

Hershey’s pricing power in the chocolate category is impressive, but its negotiating power with

retailers is not absolute. For example, when HSY announced price increases in July 2019,

some distributors and retailers accurately anticipated it and overloaded on inventory at the

original price. To prevent excess inventory from buildng further at the trade, management pulled

forward its credit terms earlier in 3Q. This created a mismatch between the price credits it

extended and the volume it actually sold to customers in 3Q. As a result, retailers captured a

bigger portion of the pricing benefit in the category than Hershey, and investors, expected.

Expansion Into Snacking Facing Some Challenges

The confectionery category’s growth rate has slowed in recent years as consumers have shifted

their snacking habits to less sugary snacking options. Hershey management has responded by

making adjacent snacks a big priority. Through the acquisition of Amplify (SkinnyPop) and

Pirate’s Booty, Hershey has established a $600M business platform outside of its core

confectionery business to mitigate pressure on confectionery from consumers shifting to

healthier snacking. To further grow the platform, it recently announced the acquisition of low-

3Q18A 4Q18 1Q19A 2Q19A 3Q19A 4Q19A FY19E 1Q20E 2Q20E 3Q20E 4Q20E FY20E

July 2018 Price

Increases 2.5%-1.2% -0.8% 0.2% 1.2% 1.1% 2.5% 1.5% 2.5% 0.0% 0.0% 0.0% 0.6%

July 2019 Price

Increase 8% on

1/3 of products

(Single-Serve)

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 1.3% 2.0% 2.0% 0.7% 1.5%

Total -1.2% -0.8% 0.2% 1.2% 1.1% 2.5% 1.5% 3.8% 2.0% 2.0% 0.7% 2.1%

7 January 2020


sugar, high protein ONE brands (about $100M in sales) and two minority investments in Fulfil

nutrition bars in the UK and Blue Stripes Cacao shop.

Hershey has tried several times in the past to extend itself outside of core confectionery, but it

has never gained much traction. Its sales trends this year indicate that its latest attempt might

be facing similar challenges. The SkinnyPop brand has performed very well, but Pirate’s Booty’

sales have been declining due to distribution losses during the sales force transition.

BarkTHINS has turned sharply negative as well after several years of growth. Overall, we

believe Hershey’s snacking business (as defined by management) will struggle to achieve the

6-8% organic growth rate that management expects for it.

7 January 2020


Figure 55: We Estimate That Less than 15% of Hershey’s Brands Are Structurally Challenged ($M)

Source: Nielsen xAOC+C, Credit Suisse estimates

$ Sales Basis (MM)

Good 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of Total

Sales

3-Yr

CAGR

1-Yr

Growth

YTD

Growth

Reese's 1,823 1,927 2,015 2,046 2,205 2,032 25% 5% 9% 9%

Ice Breakers 442 475 485 524 541 520 6% 4% 4% 4%

Skinny Pop 179 222 252 279 306 277 4% 11% 11% 10%

Cadbury 251 251 258 246 272 246 3% 3% 11% 11%

Pirate's Booty 82 86 88 96 93 95 1% 3% -2% -2%

Bark Thins 22 35 44 56 50 56 1% 13% -10% -11%

Oatmega 2 12 21 22 16 23 0% 10% -29% -29%

Bubble Yum 14 17 17 18 19 18 0% 3% 6% 7%

Paqui 1 5 14 12 14 12 0% 40% 16% 21%

Subtotal 2,816 3,030 3,195 3,298 3,517 3,279 40% 5% 7% 7%

Stable 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of Total

Sales

3-Yr

CAGR

1-Yr

Growth

YTD

Growth

Hershey Chocolate 1,793 1,768 1,705 1,784 1,830 1,780 21% 1% 3% 3%

Kit Kat 647 683 689 692 666 692 8% -1% -4% -4%

Hershey Kisses 424 433 442 424 402 423 5% -2% -5% -7%

Hershey Syrups, Spreads, and Other 410 406 407 348 393 345 4% -1% 14% 14%

Twizzlers 331 302 299 291 295 291 3% -1% 1% 2%

Mounds and Almond Joy 202 201 194 199 206 198 2% 1% 4% 4%

Payday 159 162 159 158 159 159 2% -1% 0% 1%

Hershey's Nuggets 135 140 137 135 134 134 2% -1% -1% -1%

Heath 72 71 66 63 75 63 1% 2% 20% 22%

Hershey's Kitchens 59 56 54 56 56 55 1% 0% 3% 0%

Milk Duds 53 54 49 51 51 50 1% -2% 1% 0%

Hershey's Watchamacallit 46 45 42 40 44 40 0% -1% 10% 10%

Hershey's Symphony 36 35 34 34 34 34 0% -1% 0% 1%

Subtotal 4,367 4,356 4,276 4,276 4,345 4,264 50% 0% 2% 2%

Challenged 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of Total

Sales

3-Yr

CAGR

1-Yr

Growth

YTD

Growth

Jolly Rancher 233 214 204 196 195 196 2% -3% 0% 0%

York 221 191 170 153 154 154 2% -7% 0% 0%

Hershey's Cookies n Creme 175 166 159 145 139 146 2% -6% -5% -5%

Hershey's Gold 0 0 7 74 31 76 0% NA -59% -61%

Hershey's Cookie Layer Crunch 0 6 113 70 26 74 0% 60% -65% -66%

Breath Savers 83 77 87 76 69 77 1% -3% -10% -10%

Rolo 111 89 71 64 65 63 1% -10% 2% 2%

Brookside 180 138 92 67 59 68 1% -25% -13% -13%

Whoppers 82 74 71 66 67 67 1% -3% 0% 1%

Hershey's Take 5 34 50 50 38 42 38 0% -6% 11% 14%

Krave 41 63 59 45 28 46 0% -24% -39% -41%

Subtotal 1,160 1,070 1,084 993 876 1,007 10% -6% -13% -13%

Total Sales 8,343 8,457 8,555 8,567 8,738 8,549 100% 1% 0% 2%

7 January 2020


Hormel (Neutral Rating, $38 Target Price)

Valuation

Our target price of $38 and Neutral rating reflect a valuation multiple of 15x 2020E EBITDA.

This is a 10% premium over the five-year average. The loss of pricing power in Hormel’s value-

added products and volatility of input costs represent the largest risk to our target price and

rating.

Bull Case

Best Value-Added Protein Processor in the Industry

Hormel is the leading innovator of value-added products in the protein space with iconic brands

such as SPAM, Applegate, Hormel, and Skippy. Other protein companies have tried to follow

Hormel’s footsteps, but they lack its consumer-driven culture and product development

capabilities. For example, its Bacon 1 precooked bacon line took ten years to perfect and now

dominates the foodservice market. Management has done a good job of shifting its refrigerated

mix further toward value-added and away from commodity products. It sold Farmer John in

2016 and sold its Nebraska harvesting facility in 2018. By our estimates, these actions reduced

fresh pork volume by more than 60%. At the same time, it bought the premium retail deli brand

Columbus and the Fontanini foodservice business, both of which continue to perform well.

Hormel Can Raise Price to Fully Offset Inflation

Investors believe that Hormel can successfully offset any sort of cost inflation from African

swine fever (ASF), given the strong value-added brands that it has in the portfolio. The

company successfully accomplished this task in 2014, when the PED virus affected the U.S.

hog herd and caused commodity pork prices to shoot higher.

M&A Strategy Back on the Table

Hormel has very little debt on its balance sheet and is very active in terms of M&A. The

company could make an accretive acquisition and send earnings higher as a result. This may

impress the market and send the stock higher if it’s a synergistic acquisition. It has spent $1.4

billion since FY 17 on $640M of sales (Fontanini, Columbus, and Ceratti).

For illustrative purposes, management says that it could make a $3.5 billion acquisition at a 15x

EBITDA multiple and still have a debt-EBTIDA ratio of only 2.0x. Some investors view this as a

signal that it might be interested in buying Kraft Heinz’s $3B Oscar Mayer business (excluding

Lunchables) if Kraft Heinz is willing to sell it.

Bear Case

Turkey Division (17% of Sales) Remains Unpredictable

After a long period in the mid-to-high teens, this division’s profit margin has fallen back to the

7-9% range that it used to average before 2011. Some of this division’s problems were self-

inflicted, such as the product recalls and distribution losses that negatively impacted the past

two years. In addition, it looks like the turkey industry is beginning to reduce supplies to help

boost prices. While some may believe that these factors set up Jennie-O for a rebound year in

2020, we believe that its results will remain depressed due to the long amount time it takes to

regain shelf space at retail.

Hormel May Not Sufficiently Raise Price to Offset Inflation

The high likelihood of African swine fever-related pork input inflation in 2020 poses a very

difficult environment for Hormel because it will require big price increases on a wide variety of

Hormel’s product lines. Management has repeatedly said that it has the ability to raise prices on

its products to offset inflation because of its successful track record in the past. However, when

the company raised prices 5-15% across its product line in the middle of FY19, it ended up

losing share in many categories.

7 January 2020


Unfortunate Pattern of Over-Promises from Management Team

By our reckoning, FY19 marks the third year in a row that the company has missed its internal

operating profit metrics for incentive compensation. From what we have seen, a good portion of

the misses have come from unexpected cost inflation, thus making it very difficult for investors

to believe in the pricing power of Hormel’s value-added products and its strong Foodservice

division. We believe in the company’s intrinsic ability to achieve higher pricing power over the

course of time, but in our view management will need to provide more conservative expectations

how quickly it can get it done, as opposed to the 5-7% pre-tax profit growth it has currently laid

out for the year. For example, Refrigerated Foods’ profit (58% of total company) only grew 1%

in FY19, when inflation didn’t really materialize. Why should we feel comfortable that it will grow

any faster in FY20 when inflation inevitably accelerates?

Peanut Butter Remains a Headwind

Peanut butter prices for its Skippy business have remained depressed for the majority of FY19.

There have been zero indications from Hormel’s and Smucker’s management teams that pricing

can recover in the near-term, given that competition from private label remains fierce. As a

result, Skippy’s profitability is likely to remain a drag on Grocery Products’ profitability in FY20.

7 January 2020


Figure 56: We Estimate 30% of Hormel’s Retail Brands (Less Than 50% of Total Sales) Are Challenged. ($M)


Good 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of

Sales

3-Yr

CAGR

1-Year

Growth

Hormel Black Label 449 441 509 527 557 527 14% 8% 6%

Hormel Natural Choice 135 159 184 231 232 228 6% 13% 1%

SPAM 204 203 209 209 220 210 5% 3% 5%

Hormel Gatherings (Party Platters) 109 114 115 113 124 112 3% 3% 9%

Wholly Guacamole 91 101 121 126 128 126 3% 8% 1%

Columbus 78 91 106 112 120 111 3% 10% 7%

Dinty Moore 94 93 96 100 103 100 3% 3% 3%

Herdez 55 61 71 84 93 83 2% 15% 11%

Justin's 50 70 72 75 78 75 2% 4% 4%

Subtotal 1,266 1,334 1,482 1,578 1,656 1,571 41% 7% 5%

Stable 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of

Sales

3-Yr

CAGR

1-Year

Growth

Applegate 269 291 290 305 297 305 7% 1% -3%

Sliced Lunchmeat (HRL Brand) 277 270 271 283 281 282 7% 1% -1%

Hormel Chili 222 222 218 218 214 218 5% -1% -2%

Hormel Simple Ideas 111 108 109 111 114 110 3% 2% 3%

Hormel Compleats 130 115 114 113 111 113 3% -1% -1%

Mary Kitchen 71 70 69 72 73 72 2% 1% 2%

House Of Tsang 22 22 21 22 21 22 1% 0% -2%

Festive 20 15 16 19 20 19 0% 9% 6%

Stagg Chili 13 13 14 14 14 14 0% 1% 0%

Wholly Avocado 3 3 6 11 10 11 0% 41% -13%

Subtotal 1,121 1,113 1,108 1,142 1,132 1,140 28% 1% -1%

Challenged 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of

Sales

3-Yr

CAGR

1-Year

Growth

Jennie-O 670 656 645 643 562 646 14% -5% -13%

Skippy 328 353 348 347 334 346 8% -2% -4%

Other 326 305 287 245 237 249 6% -8% -3%

Always Tender 107 93 90 85 85 85 2% -3% -1%

Lloyd's Barbeque Company 93 88 88 86 84 86 2% -1% -2%

Hormel Bacon Toppings 75 78 64 61 60 60 2% -8% -1%

Hormel Potatoes 40 38 36 33 28 33 1% -9% -14%

Valley Fresh 32 20 22 21 20 21 1% 0% -6%

Herb-Ox 17 16 15 15 15 15 0% -3% -3%

Subtotal 1,688 1,647 1,595 1,536 1,425 1,543 36% -5% -7%

Total Hormel 3,940 3,944 4,007 4,059 4,006 4059 105% 1% -1%

7 January 2020


Kellogg (Outperform Rating, $78 Target Price)

Valuation

Our Outperform rating and target price of $78/share assumes an 18.5x P/E multiple against

our 2021 EPS estimate. This assumes that the stock’s valuation premium to its food peers

increases to 10% compared to a 0% premium today. With its organic revenue growth rate now

at 2%, we think Kellogg’s stock deserves to be placed in a higher valuation echelon among its

consumer staples peers. Continued weakness in the U.S. cereal business represents the

biggest downside risk to our target price.

Bull-Case

Leading Market Share in Important Global Categories

Kellogg maintains a leading position in a number of important food categories with a portfolio of

strong iconic brands such as Special K, Frosted Flakes, Pringles, and RXBar. The company is

the largest global manufacturer of cereal (about 40% of sales) and is the second-largest global

snacks company (50% of sales). Its Eggo, Morningstar, and Pop Tarts brands provide additional

breadth to its strong position in the U.S. breakfast market.

Potential for Inflection in Margins and Profit Growth

Over the past few years, the dilutive impact of acquisitions of faster-growing businesses,

reinvestment spending (especially in single-serve packaging), and sales declines in high-margin

North America cereal have caused Kellogg’s gross margin and operating margin to fall 200 and

500 bps below its food peer averages respectively. Based on our analysis, the North American

Cereal and Snacks division’s margins are now 400-500 bps below their closest peers General

Mills and Mondelez.

We expect Kellogg’s margins to improve gradually over the next few years as the dilutive factors

impacting the gross margin begin to reverse and sales growth from investment spending begins

to generate operating leverage. Specifically, we expect 40 bps of gross margin expansion in 2020 from the accretive impact of divesting Keebler assets and a 20 bp benefit from stabilizing

the North American cereal business.

Above-Peer Organic Revenue Growth

Kellogg has shifted the concentration of its portfolio more toward snacks and emerging markets

rather than breakfast cereal in developed markets. This has boosted Kellogg's organic growth

rate above 2%, which exceeds its food peers by a significant margin. Differentiated U.S. brands

like Cheez-It, Pringles, Eggo, Pop-Tarts, and Morningstar are growing at a strong rate. Cheez-It

has grown at a double-digit pace this year in the cheese cracker category by maintaining strong

product quality over competition. Pringles is up 4% behind effective "flavor stacking" advertising

campaigns and more on-the-go packaging. Pop Tarts is up double-digits this year after

launching on-the-go Pop Tart Bites.

We estimate that that the acquisitions of the fast-growing RXAR and Tolaram businesses added

over $1 billion of sales to the portfolio and the divestiture of U.S. Keebler assets (cookies/fruit

snacks/cones) subtracted $900 million. By our math, these transactions boosted the growth

profile of Kellogg’s portfolio by 130 bps.

7 January 2020


Figure 57: By Our Math, Portfolio Changes Have Boosted Kellogg’s Organic Growth

Rate by 130 bps

Source: Company data, Credit Suisse estimates, Nielsen AOCx. Used Nielsen data for 2014-2017 to calculate

growth rate for divested Keebler, fruit snacks business

North American Cereal Problems Largely Self-Inflicted

North American cereal is the glaring exception to Kellogg’s return to growth over the past two

years, down 5% year-to-date. Our view is that a good portion of the company problems in

cereal are self-inflicted. When Kellogg’s attempts in the mid 2010’s to defend its brands health

and wellness credentials failed to gain traction, it exacerbated its problems by shifting its

resources further into indulgent snacks instead. R&D spending and marketing support for cereal

declined. In comparison, General Mills has gained market share by creating effective heart-

health news for its Cheerios brand and extending it into new varieties

With consumption trends in the overall U.S. cereal category now stabilizing and Kellogg's supply

chain disruption now in the rear view mirror, we believe North American cereal has a good

chance of stabilizing in 2020. We find it encouraging to hear management recognize the

seriousness of the situation and commit to making North America Cereal a bigger priority. In our

view, brands like Frosted Flakes, Rice Krispies, Mini Wheats, and Special K still resonate with

consumers if given sufficient attention. If the cereal business merely keeps pace with the

current U.S. cereal category growth rate, it will fulfill its role in the Kellogg portfolio.

Cash Flow Conversion Will Improve

Kellogg’s free cash flow conversion ratio has trailed its peer group over the past three years.

We expect two factors driving this dynamic to improve in 2020. First, Kellogg’s capital

expenditures are likely to fade back to more normalized levels now that it has come to the end

of its investment phase in new packaging lines. Second, we expect negligible restructuring

changes now that the company has come to the end of its multi-year $1.4 billion Project K

restructuring program.

With the company’s Net Debt to EBITDA ratio now back to a very conservative level of 3.3x, we

believe the company will allocate more cash flow to share repurchases in 2020 than the $200M

it spent in 2019.

Underappreciated Emerging Market Exposure

Emerging market sales compose roughly 20% of Kellogg’s annual sales. Management views

emerging markets (specifically the AMEA region) as an important driver. Acquisitions in Nigeria,

Egypt, and South Africa have provided more scale in regions. These regions offer strong GDP

growth and a growing middle class. Management aims to reach consumers of many income

levels through a wide range of price points across cereal, snacks, noodles, and biscuits. It will

address nutrient gaps for breakfast in lower-income demographic. In Africa, Kellogg has 51%

Prior Mix

Est

Growth

Rate New Mix

Est

Growth

Rate

Kellogg Core 12,400 0.0% 12,400 0.0%

RXBAR 180 15.0%

Tolaram 900 12.0%

Divested Keebler, Fruit 900 -4.0% -

Total Kellogg 13,300 -0.3% 13,480 1.0%

Difference in Growth Rate 1.3%

7 January 2020


ownership of Multipro (a distributor), a joint venture with Tolaram (branded products seller), and

25% ownership of Dufil (branded noodles manufacturer).

Bear Case

Weak Quality of Earnings and Low Free Cash Flow

By our math, the combined impact of “ongoing” restructuring charges and non-cash actuarial

income from benefit programs “overstate” Kellogg’s EPS and understate its P/E by 11%

compared to its food peers. Kellogg’s weak pattern of free cash flow generation also suggests

weak earnings quality with free cash flow per share amounting to only 64% of its adjusted EPS

in 2018 and 76% over the past three years.

Figure 58: After Adjusting EPS Estimates for “Ongoing” Restructuring and Benefit

Accounting, We Find That Investors are Paying a Significant Premium for CPB and that

K is Trading at a Significant Premium to its Closest Peer, GIS

Source: Company data, Credit Suisse estimates; Stock prices and forward EPS estimates from FactSet as of

12/1/19.

Figure 59: Kellogg, Kraft Heinz, and Mondelez have Very Low Free Cash Flow Per Share in Relation to Their EPS; Campbell has

Very High Free Cash Flow Per Share. For SJM, the Major Difference Between FCF/Share and EPS Relates to Smucker’s Ongoing

Practice of Excluding $2.11 of Amortization Expense When it Presents Adjusted EPS in its Results

Source: Company data, Credit Suisse estimates. Kellogg and Kraft Heinz’s free cash flow includes collections from securitized trade receivables 2016-2018 before their

accounting restatements

Cal 20

P/E

Adj Cal 20

P/E

Change in P/E

after EPS

Adjustment

CPB 17.9 CPB 20.3 14%

K 16.3 K 18.1 11%

CAG 13.0 CAG 14.4 11%

KHC 11.9 KHC 13.2 10%

MDLZ 19.9 MDLZ 20.8 4%

SJM 13.0 GIS 15.7 1%

GIS 15.6 SJM 13.0 0%

MKC 30.1 MKC 29.9 -1%

HSY 24.2 HSY 23.9 -1%

Avg 18.0 Avg 18.8 5%

Company EPS 3 Yr FCF/Share 3 Yr

FCF per Share/Adj. EPS 3

Year EPS 1 Yr

FCF/Share 1

Yr

FCF per

Share/Adj. EPS 1

Year

CPB 8.52$ 9.43$ 111% 2.61$ 3.35$ 129%

GIS 9.41$ 10.27$ 109% 3.22$ 3.75$ 116%

HSY 14.38$ 9.19$ 64% 5.36$ 6.05$ 113%

MKC 13.02$ 13.79$ 106% 4.98$ 4.90$ 99%

CAG 5.86$ 5.79$ 99% 2.01$ 1.90$ 94%

SJM 23.97$ 22.19$ 93% 8.29$ 6.85$ 83%

MDLZ 6.41$ 3.98$ 62% 2.43$ 1.92$ 79%

KHC 10.32$ 5.15$ 50% 3.52$ 2.50$ 71%

K 12.07$ 9.19$ 76% 4.33$ 2.75$ 64%

7 January 2020


Management Track Record

The company’s long list of execution missteps and bad choices over the past several years have

led to significant underperformance of the stock, declining returns on capital and some loss of

confidence among investors. The company has missed its financial targets for executive

compensation in five of the past seven years. Investors who were long Kellogg in 2018 still feel

bruised by the suddenness of its forecast reduction in 3Q, (which revised down operating profit

by 6%) and the dilutive impact of the Keebler divestiture.

Kellogg’s North American Cereal sales may not stabilize as quickly as we expect.

Recent signs of stabilization in the North American cereal category may turn out to be overly

optimistic. Consumers have been exiting the cereal category because they are shifting to higher

protein diets and they view cereal as too sugary, carb-heavy and gluten-heavy to be considered

a healthy meal. Kellogg’s cereal business has high exposure to the health and wellness

segment of the category (about 44% of sales) which has felt the most negative impact from this

shift in dietary preferences.

Management has yet to lay out a compelling strategy or the investment necessary to defend its

health and wellness credentials, particularly for struggling brands like Special K, Kashi, and Mini

Wheats. If Kellogg introduces overly aggressive price promotions to regain market share rather

than innovative products and ideas, it will have a dilutive impact on Kellogg’s margin structure.

We believe consensus estimates for 2020 EPS are too high.

In our estimates, we have taken into account the full impact of dilution from the Keebler

divestiture and the likelihood that Kellogg will reinvest the benefit of its 53rd week back into the

business. We believe consensus has underestimated the impact of these factors. However, we

think the market will pay more attention to fundamental organic revenue growth and organic

operating income growth as opposed to EPS when management provides guidance for 2020.

We expect organic operating income growth to accelerate to 3-4% in 2020 compared to flat in

2019. We are above consensus for 2021.

7 January 2020


Figure 60: Ready-to-Eat Cereal Sales Have Declined at the Same Pace as Cigarette

Sales over the Past Four Years in Terms of Volume Consumption

Source: Nielsen, xAOC through 2018, Credit Suisse estimates

88

90

92

94

96

98

100

102

2013 2014 2015 2016 2017 2018

RTE CEREAL CIGARETTES

RTE CerealCAGR: -2.4%Cigarettes CAGR: -2.4%

7 January 2020


Figure 61: We Estimate That 42% of Kellogg’s Portfolio Is Structurally Challenged ($M)


Kraft Heinz (Underperform, $27 Target Price)

Valuation

Our $27 target price assumes a 10.5x EV/EBITDA multiple against our 2020 estimate. Even if

the company stabilizes EBITDA, we think the stock will trade at a ~11% discount to its peers

due to its challenged portfolio and inconsistent track record. Sales growth without additional

investments represents the upside risk to our price target.

Good 2015 2016 2017 2018

Last 52-

Weeks

% of

Total

Sales

3-Yr

CAGR

1-Yr

Growth

Cheez-it 943 991 1,008 1,042 1,185 14% 6% 14%

Pringles 808 821 782 831 859 10% 2% 4%

Pop-Tarts 760 766 738 736 815 10% 2% 11%

Eggo 746 721 749 797 800 10% 4% 1%

Rice Krispie Treats 285 282 292 323 362 4% 9% 12%

Morningstar Farms 286 262 281 305 321 4% 7% 5%

RXBAR 0 4 46 132 142 2% 218% 11%

Bear Naked 73 65 77 79 79 1% 7% 0%

Subtotal 3,900 3,913 3,973 4,244 4,563 55% 5% 8%

Stable 2015 2016 2017 2018

Last 52-

Weeks

% of

Total

Sales

3-Yr

CAGR

1-Yr

Growth

Keebler Club 237 243 255 255 256 3% 2% 0%

Subtotal 237 243 255 255 256 3% 2% 0%

Challenged 2015 2016 2017 2018

Last 52-

Weeks

% of

Total

Sales

3-Yr

CAGR

1-Yr

Growth

Kellogg RTE Cereal 2,619 2,585 2,452 2,393 2,327 28% -3% -3%

Kashi 309 260 232 206 186 2% -10% -10%

Nutri-Grain 225 219 202 190 194 2% -4% 3%

Keebler Townhouse 220 217 198 185 164 2% -9% -13%

Other Keebler 193 189 169 168 170 2% -4% 2%

Austin 131 122 114 105 101 1% -6% -3%

Other (mostly Special K bars and shakes) 567 424 329 279 214 3% -20% -26%

Special K Pastry Crisps 84 74 54 58 51 1% -12% -12%

Keebler Zesta 57 52 48 46 43 1% -6% -7%

Special K Nourish 19 34 21 22 9 0% -37% -37%

Subtotal 4,423 4,176 3,818 3,652 3,459 42% -6% -6%

Total Company Sales 8,560 8,331 8,046 8,152 8,278 101% 0% 2%

7 January 2020


Bull-Case

Leading Brands

Kraft Heinz has a portfolio of well-known brands with number-one or -two positions in 17 of its

largest categories, representing roughly 80% of sales. These include the Kraft brand, Oscar

Mayer, Maxwell House, Jell-O, and Planters. Heinz has products with number-one or -two

shares in more than 50 countries, including the Heinz brand of ketchup (number one in the U.S.

and globally), Ore Ida (number one in U.S. frozen potatoes), ABC (number two in Indonesian

soy sauce), and Quero (number one in Brazilian frozen vegetables).

2019 Might Signify the Bottom for Margins

After a weak 1H of 2019 and a humbling 2018, EBITDA margins have revised 600 bps lower

from their 2017 peak. To some, this might signify a defensible base for earnings and margins

from which the company can start its “Path to Normalization.” New CEO Patricio seemed to

indicate on the last earnings conference call that the business may not necessarily need another

round of incremental investment to pivot to growth. Instead, Patricio wants to emphasize

allocating SG&A expenses more effectively and developing a stronger process for ongoing

productivity in the supply chain. But from our perspective, Kraft Heinz’s EBITDA margin of 24%

is still quite high in relation to its peers at 21% on average. For context, Kraft and Heinz

businesses operated at an average EBITDA margin of only 19% prior to 3G acquiring and

merging them.

Figure 62: KHC EBITDA Margin is Still High Compared to Peers

Source: Company data, Credit Suisse

Highly Experienced Investors Own the Stock

Bulls on this stock believe that the “all-star cast” of investors who control this company (3G,

Berkshire) are clever enough to figure out a way to recoup their losses on this investment in the

fullness of time. For example, Berkshire and 3G may decide to make an equity infusion in the

business, issue preferred stock, or issue convertible bonds to assuage the concerns of the debt

rating agencies.

25%

24%

22% 22%21% 21%

20%

19%

18%

17%

15%

17%

19%

21%

23%

25%

27%

HSY KHC SJM MKC CPB GIS MDLZ CAG BGS K

7 January 2020


Bear Case

Seriousness of Balance Sheet and Potential Bond Downgrade

We continue to view a dividend cut as likely outcome when the company finishes its strategic

review in early 2020. S&P Global Ratings wrote on October 31 that Kraft Heinz will need to

take “near term actions” to reduce its debt-EBITDA leverage to 4.0x by mid-2021 and avoid a

ratings downgrade. EBITDA has shown signs of stabilization at $6.0 billion, but we expect the

impact of divestitures and a reset in incentive compensation to send EBITDA to $5.8 billion and

increase the leverage to 4.8x by the end of 2020. The company is currently barely generating

enough cash flow to pay its dividend. As a result, we don’t think management has any other

viable options if intends to make good on its commitment to maintaining its investment grade

rating.

Some investors believe that the company will sell premium assets to accelerate debt reduction.

However, S&P wrote that it would not look favorably on a capital structure plan that relies solely

on future asset sales that have limited visibility and execution risk. As a result, we don’t expect

the company to announce a major divestiture when it unveils its strategic plan

Figure 63: 2020 EBITDA and EPS Bridge


Earnings Quality Is Among the Worst in the Group

By our math, the combined impact of “ongoing” restructuring charges and non-cash actuarial

income from benefit programs “overstate” Kraft Heinz’s EPS and understate its P/E by 11%

compared to its food peers. This is partly because the company is currently including a $300M

per year benefit from amortizing gains related to the discontinuation of a corporate health care

plan. However, the amortization benefit will sharply decline from $306M in FY19 to $122M in

FY20 and to $8M in FY21.

Over the past three years, Kraft Heinz has taken the most restructuring and impairment charges

in the food group as a percentage of its adjusted EPS.

EBITDA

Pre-Tax

Income Impact EPS/Impact

2019 6,062 $2.82

Incentive Comp Reset (100) ($0.07)

Divestitures & Business Exits

(Canada and McCafe )(100) ($0.07)

Business Reinvestment (83) ($0.05)

Other Expenses (Income) (165) ($0.11)

Interest Expense (43) ($0.03)

Higher Tax Rate ($0.04)

2020 5,779 $2.45

7 January 2020


Figure 64: Cumulative Past Three Years Restructuring and Impairment Charges as % of Adjusted EPS

Source: Company data, Credit Suisse estimates; Restructuring charges include: restructuring, impairment, and integration charges

3G Companies Are Not Designed to Pivot to Growth

As with most of the consumer companies in its portfolio (e.g. Burger King, Budweiser), the

private equity firm 3G put Kraft and Heinz together in 2016 with the idea that it could operate

the business at a much lower cost than food peers while maintaining the brands. Through a

strict Zero-Based Budgeting process, 3G companies boost margins through dramatic cuts to

overhead costs and supply chain consolidation.

But in the case of Kraft Heinz, the cuts carved into the muscle of the organization and starved

the brands of investment. The antiquated Kraft Heinz brands proved unable to keep up with

consumers’ growing preference for more entrepreneurial, natural brands. Retailers like Walmart

and Kroger, which had been investing in e-commerce to compete against Amazon, reacted

negatively to the company’s approach and reduced the brands’ shelf space in favor of private

label. Board member Jorge Lehmann said publicly that the massive changes in technology and

consumer preferences in the industry made him feel like a "scared dinosaur.”

Kraft’s new CEO Miguel Patricio now has the unenviable task of transforming a company that

was envisioned as a cost-cutter into a company that can generate organic growth. Even if he

gets permission from the board to increase investment spending behind the brands to do it, the

progress undoubtedly will be slow. About 44% of Kraft Heinz’s U.S. retail portfolio competes in

commoditized categories (like cheese, meats, coffee, and nuts) where the company has been

losing share to private label or more on-trend brands. Management says that insufficient training

in personnel and process at the manufacturing facilities has caused “double-digit” losses in the

supply chain in the last few years.

Big Impairment Charges Reflect Reduced Outlook

The company announced $15.9 billion of impairment charges in February and May (primarily on

the Kraft and Oscar Mayer brands) and then another $1.2 billion in its first half results in the

international businesses and in U.S. Refrigerated. We view this as recognition that the

company’s cash flow generation will be significantly below what it originally anticipated pre-

merger even if the turnaround efforts succeed. Additionally, The CFO stated in August that

there is an ongoing risk of future impairments given “any change in forecast or modeling

assumptions that can trigger” it. In our view, this comment raised the possibility that the

company might decide to rebase its EBITDA even lower in 2020 due to incremental investment

needs rather than “self-fund” the investment with internal savings.

120.9%

55.4%

25.9% 22.0% 21.2%

17.3% 13.3% 11.2%

4.2%

KHC CPB SJM CAG MDLZ K HSY GIS MKC

7 January 2020


Figure 65: Over 30% of Kraft Heinz’s Global Sales Are Exposed

to Commodity Cheese and Meats

Figure 66: Over 50% of Kraft Heinz’s U.S. Retail Sales ($21B)

Are Exposed to Commodity Cheese, Meats, Nuts, and Coffee

Source: Company data, Credit Suisse. 10-K Source: Company data, Credit Suisse estimates

Condiments and sauces

25%

Cheese and dairy

21%

Ambient meals

9%

Frozen and chilled meals

10%

Meats and seafood

10%

Other25%

Regular Cheese18%

Sliced meat11%

Lunchables7%

Dry dinners 7%

Nuts and seeds6%

Cream cheese

6%

Bacon5%

Juices4%Ground coffee

4%

Frozen potatoes3%

Beverage enhancers

3%

Mayonaisse3%

Condiments3%

Single serve coffee

2%

Frozen meals and apetizers

4%

Salad dressing 2%

Other 15%

7 January 2020


Figure 67: We Estimate That Roughly 53% of Kraft Heinz’s Portfolio Is Structurally Challenged ($M)


Good 2015 2016 2017 2018 L52 Wks

% of Total

2019 Sales 3-Yr CAGR

L52 Wks

Growth

Lunchables 1,252 1,314 1,352 1,336 1,343 6% 1% 1%

Philadelphia 981 1,045 1,085 1,154 1,216 6% 5% 6%

Heinz 848 890 910 959 992 5% 4% 4%

Kraft Mac & Cheese 763 746 748 787 808 4% 3% -1%

Cracker Barrel 247 300 313 317 315 2% 2% -1%

Mc Café 182 220 278 295 291 1% 10% -2%

Classico 241 242 256 264 268 1% 3% 2%

T.G.I. Friday's 209 210 221 237 250 1% 6% 7%

Claussen 178 178 179 194 203 1% 4% 5%

Bagel Bites 148 146 152 160 162 1% 3% 1%

Devour - 24 52 73 93 0% 58% 32%

Subtotal 5,048 5,317 5,546 5,775 5,941 28% 4% 3%

Stable 2015 2016 2017 2018 L52 Wks

% of Total


L52 Wks

Growth

Other Brands 2,790 2,674 2,547 2,595 2,683 13% 0% 4%

Jell-O 578 563 559 553 572 3% 1% 4%

Crystal Light 299 286 285 295 303 1% 2% 3%

A.1. 156 156 152 158 164 1% 2% 5%

Stove Top 145 141 141 144 143 1% 0% -2%

Subtotal 3,968 3,820 3,683 3,745 3,865 19% 0% -67%

Challenged 2015 2016 2017 2018 L52 Wks

% of Total


L52 Wks

Growth

Oscar Mayer 3,583 3,376 3,265 3,280 3,241 16% -1% -1%

Kraft Cheese 2,623 2,576 2,498 2,388 2,276 11% -4% -5%

Velveeta 1,185 1,179 1,155 1,113 1,089 5% -3% -3%

Planters 1,384 1,332 1,226 1,060 1,066 5% -7% 0%

Maxwell House 890 837 793 749 669 3% -7% -11%

Ore-Ida 662 647 647 602 609 3% -2% 1%

Kool-Aid 580 568 529 530 548 3% -1% 4%

Capri Sun 586 538 505 482 483 2% -4% 0%

Miracle Whip 328 325 303 288 283 1% -5% -2%

Smart Ones 442 349 286 233 216 1% -15% -8%

Cool Whip 235 234 223 212 214 1% -3% 0%

Breakstone's 226 224 217 207 195 1% -5% -6%

Gevalia 241 225 204 195 188 1% -6% -3%

Subtotal 12,966 12,410 11,850 11,337 11,078 53% -4% -2%

Total 21,982 21,547 21,080 20,857 20,884 100% -2% 0.1%

7 January 2020


Figure 68: Proceeds from Divestures Helped Reduced Net Debt by $1.875B, But This

Might Not Be Sufficient To Avoid a Debt Downgrade or Dividend Cut

Source: Company data, Credit Suisse estimate

McCormick (Neutral Rating, $160 Target Price)

Valuation

Our $160 target price assumes a 26.0x P/E multiple against our 12-month forward EPS

estimate. This is in-line with other consumer staples that have leadership positions in attractive

niche markets, such as Clorox and Church and Dwight. Accelerated market share losses to

private label pose the largest threat to our thesis.

Bull Case

Scarcity of “Growth” Consumer Staples Justify Premium Valuation

Valuation multiples of high-quality mid-cap staple companies with strong growth rates have

expanded, while multiples for slow-growth and competitively challenged big food companies

have compressed. We think this reflects investors’ desire for safe haven names to protect from

an economic slowdown and recognition that there are fewer legitimate growth stories within the

traditional staples sector. McCormick, Church & Dwight, Clorox, and Hormel stocks have all

enjoyed significant multiple expansion because they have defensible market shares in niche

categories and legitimate 3-4% organic growth rates due to ongoing productivity and

reinvestment.

$28,200

$29,907 $30,038

$27,937

$27,499

$26,000

$26,500

$27,000

$27,500

$28,000

$28,500

$29,000

$29,500

$30,000

$30,500

2016 2017 2018 2019 2020E

7 January 2020


Figure 69: The Highly Valued Mid-Cap Consumer Staple Stocks Are Few and Far

Between

Source: FactSet, Credit Suisse estimates. Big Food average includes CAG, CPB, GIS, HSY, K, KHC, MDLZ,

MKC, SJM. Data as of 01/02/19

Relatively Unaffected by U.S. Private Label Expansion

McCormick’s branded spice and seasonings business continues to grow despite losing share to

private label. Retailers that expanded private label in 2018 made room for it by discontinuing

third-tier regional brands rather than removing McCormick. By 2019, McCormick’s brands

generally held share and private label’s share stagnated. We believe that McCormick’s category

management capabilities, strong new products, and private label manufacturing flexibility provide

a high degree of insulation from the private label threat.

On-Trend Category with Positive Demographic Tailwinds

While the vast majority of packaged foods companies have felt the pressure of shifting

demographics and changing dietary preferences, the spice and seasonings category remains a

structural growth story, with consumption up another 4% in 2019. Millennials’ interest in exotic

foods with bolder flavors continues to grow, as does the focus on healthy eating. Consumers

are looking for ways to reduce their intake of sugar and artificial ingredients.

The company's portfolio is well positioned to cater to the strong demand for flavoring, led by a

McCormick brand that over-indexes with Millennials. With a 35% share of the U.S. spice and

seasonings category and 10x the size of the next branded competitor, McCormick enjoys

category leadership and pricing power like no other company in our coverage. The $4.2 billion

RB Foods acquisition extends its breadth by making it the #2 branded player in the highly

fragmented condiments category, up from #10 at retail. Before that, it had only $110M

(approximately) in sales with McCormick Grill Mates, Lawry's, and Stubb's products. As a result

of these competitive advantages, its organic growth rate of 3% over the years has far exceeded

packaged foods peers.

RB Foods Bolstered McCormick’s Leadership in Flavors and Provided Synergies

While RB Foods performed well over the past 10 years at a growth rate of 5%, its owner,

Reckitt Benckiser, treated it as a noncore business and did not give it resources to expand

internationally or fully exploit opportunities for growth domestically. In contrast, McCormick is

treating the Frank’s and French’s brands as a big priority and providing them with substantial

resources for growth. In the U.S, the Consumer team filled distribution gaps on Frank’s Redhot

and extended the brand to new categories. For French’s mustard, McCormick utilized the same

strategy it successfully employed in herbs and spices to help retailers increase the profit pool by

raising prices of private label and value brands.

In U.S. foodservice, the acquisition has transformed the company from a back-of-the-house

ingredient supplier to a higher-value, front-of-the-house player. It has an excellent opportunity to

put more of its high-value brands (such as Old Bay and Lawry's) on the table. According to

NTM P/E 19-Jan Current

McCormick 23.3 29.9

Clorox 22.5 24.2

Church & Dwight 25.7 26

Hormel 22.7 25.1

Average 23.6 26.3

Overall Big Food Average 14.3 16.8

7 January 2020


management, the complementary nature of the acquisition boosted foodservice’s points of

distribution by over 19,000 new restaurant locations.

Strong E-commerce Operations

McCormick is frequently recognized by its peers in the industry as a leader in e-commerce.

Management took the view early on that it needed to allocate resources disproportionately to

Amazon and other e-retailers to capitalize on the growth in the channel. Its e-commerce sales

are growing over 31% to pure-play customers while U.S. omni-channel digital sales have grown

roughly 94%. The electronic media consulting firm L2 gives McCormick high praise for its digital

marketing efforts, ranking it first out of 126 food brands in terms of digital marketing

effectiveness.

We think McCormick is particularly well positioned to capitalize on e-commerce because

consumers so frequently search the internet when looking for new recipe ideas and because its

small-sized, high-price products fit so well as an add-on to full-basket shopping occasions or

recipe-driven searches.

Underappreciated Industrial Division

The large improvements in the company's Industrial division (39% of profits) have been a major

contributor to the company's profit growth. Of this division's sales, half go to food service

distributors and half to food processors. Its customers include 9 of the top 10 food processors

and all of the top 10 foodservice distributors and restaurant chains.

We expect this division to continue to capitalize on favorable underlying growth trends. Food

processors have been developing new formulations and new products to improve their health

and wellness credentials. Customers in emerging markets (especially China) have been

investing for growth again and seeking more value-added solutions. The acquisitions of Giotti

and Brand Aromatics have provided a high degree of revenue synergies by (1) helping

customers in processed foods add flavor to “natural” products (especially in poultry and

processed meat) and (2) enabling McCormick to attain access to more value-added business in

Europe.

Figure 70: Industrial Margins Have Expanded ~110 bps per Year Since 2013, While

Organic Growth Has Averaged 3.6%


7.5%

8.3%

9.5%10.0%

11.9%

14.2% 14.4%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

2013 2014 2015 2016 2017 2018 2019E

-

50.0

100.0

150.0

200.0

250.0

300.0

350.0

EBIT EBIT Margin Organic Sales

EBIT ($M)

7 January 2020


M&A Activity Is Likely to Re-Accelerate

After paying down debt from the 2016 RB acquisition, McCormick’s financial leverage is back

down to 3.3x and management says that the company is prepared to get back to its normal

pace of M&A. The company has a long and successful track record with 9 of the 11 deals

meeting or exceeding synergy expectations by our calculations. Management defines

acquisitions as an important part of the company’s algorithm for growth, representing 2% per

year to sales on average. As in the past, we believe that the company will target small flavoring

companies that increase the capabilities of its Industrial division to provide organic and natural

solutions for customers. Dupont and IFF’s recent merger announcement may increase

McCormick’s sense of urgency in that regard.

Bear Case

Stock Looks Over-Valued, Especially In Relation to Rising IT Investments

The stock is now fetching a significantly higher valuation multiple than its packaged food peers’

average because the market implicitly expects the company to consistently deliver its sales and

EPS growth targets. But in fiscal 2020, the company’s EPS growth rate will feel a negative

impact from investments to replace existing, disparate ERP systems with SAP HANA.

According to management, the total cost of the ERP investment is to range between $150 to

$200 million over the three years starting in 2019, with approximately 60% in capital spending

and 40% in operating expense. We think this entails incremental operating expenses of $10-

$20 million in FY 20 (about $0.06-$0.12/share) in FY 20 depending on how the company

spreads the investment. The company’s current SAP platform won’t be decommissioned until

2025, but McCormick management wanted to speed up the process.

Private Label Share Gains May Erode McCormick’s Growth over Time

While McCormick’s pricing power stands out within its group, the company is not immune to

private label expansion. When private label gains momentum at a pace this rapid (market share

up 470 bps versus 2017), retailers have more leverage over their vendors in category

management discussions. Some of the private label sales growth is optical in nature (as a result

of Sam’s Club buying Tone’s brand from B&G with a reclassification to private label), but further

share losses could prompt investors to reduce faith in McCormick’s brand equity.

Inventory Reductions at Retail May Resurface

In 4Q18 (the company’s most important quarter of the year), the company missed its sales and

EPS estimates by a significant degree because a handful of big retailers mysteriously reduced

inventory on McCormick’s seasonal spice and seasoning products heading into the holiday

season. McCormick said that some of these reductions related to “ordering glitches” at one

specific retailer.

The company’s sales trends quickly returned to normal in 1Q19 and we don’t see any reason to

believe that another inventory de-load is coming in 4Q19. However, generally speaking, we

view McCormick’s spice and seasonings business as more vulnerable to inventory de-loading

than its food peers because its products have intrinsically lower “turn rates.” To that end,

management says that it assumes a 1% headwind to sales in its annual forecasts for the sake

of conservativism in case inventory de-loading reoccurs.

7 January 2020


Figure 71: We Estimate 17% of McCormick’s Brands Are Challenged ($M)


Good 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of

Total

Sales

3-Yr

CAGR

1-Yr

Growth

MKC Herbs & Spices 350 357 358 356 353 356 12% -0.4% -0.9%

Lawry's 201 209 216 219 223 218 7% 2.2% 2.2%

MKC Extracts 127 134 149 169 181 164 6% 10.4% 10.0%

MKC Gravy 130 133 137 148 152 147 5% 4.5% 3.1%

Frank's Redhot 119 133 139 151 171 149 6% 8.8% 14.3%

MKC Latino 90 96 100 113 119 112 4% 7.5% 6.6%

MKC Chili Sauce 63 63 62 70 73 70 2% 5.4% 5.0%

Gourmet Garden 41 52 63 70 73 70 2% 12.0% 4.3%

Kitchen Basics 60 62 63 69 69 69 2% 3.5% 0.0%

Thai Kitchen 48 55 58 60 61 60 2% 3.9% 2.3%

MKC Salt 40 42 45 49 52 49 2% 7.0% 5.9%

Stubb's 45 41 40 42 45 42 1% 2.5% 5.8%

Old Bay 35 39 39 41 46 40 2% 6.1% 13.9%

MKC Mayo 28 28 29 33 37 32 1% 10.1% 14.7%

MKC Onion 27 27 27 28 29 27 1% 3.5% 7.3%

Simply Asia 17 14 13 17 17 17 1% 6.9% -1.2%

Subtotal 1,422 1,484 1,538 1,635 1,701 1,624 57% 4.7% 4.7%

Stable 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of

Total

Sales

3-Yr

CAGR

1-Yr

Growth

Other MKC Brand 201 209 212 205 202 205 7% -1.1% -1.6%

MKC Seasonings 207 213 211 213 219 213 7% 1.0% 2.8%

MKC Peppercorn 145 159 151 144 144 144 5% -3.1% 0.6%

MKC Hot Peppers 58 60 59 58 58 58 2% -1.2% 0.9%

MKC Garlic 53 54 56 57 58 57 2% 2.2% 1.2%

Subtotal 664 694 690 677 681 677 23% -0.6% 0.7%

Challenged 2015 2016 2017 2018

Last 52-

Weeks

Last 52-

Weeks

YA

% of

Total

Sales

3-Yr

CAGR

1-Yr

Growth

French's 282 277 269 264 255 266 9% -2.7% -3.9%

Zatarain's 219 218 204 200 210 200 7% -1.1% 5.5%

El Guapo 41 37 35 37 38 36 1% 0.2% 3.4%

5th Season 55 48 30 0 0 0 0% -97.3% -98.3%

Cattlemen's 7 6 5 5 5 5 0% -5.3% -1.6%

Subtotal 603 586 544 506 508 507 17% -4.6% 0.3%

Total Company 2,826 2,892 2,893 2,935 3,001 2,924 100% 1.2% 2.6%

7 January 2020


Mondelez (Outperform Rating, $60 Target Price)

Valuation

Our 12-month $60 target price reflects a 21.5 P/E multiple on our forward EPS estimate.

Volatile conditions in emerging markets pose the largest risk to our estimates and target price.

Bull Case

Broad International Footprint with Great Brands

The global snacks category is growing at a stronger pace than that of broader food. Time

compression leads to more snacking occasions during the day and fewer formal meals. Per

capita consumption of western snack brands grows rapidly in emerging markets as GDP rises

and consumers shift to premium brands.

With roughly 70% of its sales in international markets and 40% in developing markets,

Mondelez appears well positioned to capitalize on economic growth abroad. Its portfolio of big

global brands includes Oreo, Cadbury, Milka, LU, Stride, and Trident and provides many

opportunities to expand into “white spaces” such as chewing gum and chocolate in China,

chocolate bars in the United States, and “choco-bakery” in Europe. Consumption trends for

CPG in China have accelerated behind growing GDP in second-tier cities. The company notes

its newly launched products in India are attracting incremental sales. Importantly, Mondelez’s

West European business has returned to positive growth behind effective advertising and trade

support in the UK and a distribution recovery in Germany.

“Local First” Strategy is On-Track

After years of focus on cost controls that starved the brands, CEO Dirk van de Put has

successfully shifted the focus of the company back to topline growth and gross profit “dollars”

instead of margins. The new “Local First” approach decentralizes decision-making and gives

country business managers more authority and resources. Regional leaders now have

permission to put more focus on the local jewels in their portfolios rather than just the global

brands. Investments in local route-to-market distribution and supply chain flexibility give them

the ability to expand the reach of the brands to a broader set of consumers in emerging markets.

India, for example, can put more focus on 5c single-serve products rather than $2 Cadbury

chocolate bars. The AMEA region in general will increases its points of distribution by 35% to 5

million.

In addition, management rearranged its compensation structure, which now gives more rewards

(and penalties) for managerial performances all the way down to the country level. We believe

this is a positive for the company as it encourages more accountability.

With this new strategy, Monelez’ organic growth rate has accelerated from 1.0% in 2017 to

3.5%+ in 2019 and is well on its way to 4-5% in our view. We believe the valuation multiple will

re-rate 2-3 turns higher as the higher growth rate puts the stock in the league of high quality,

multi-national peers like Pepsico, Nestle, and Unilever.

Improved Margin Structure Appears Sustainable at 17%

Mondelez improved margins by 380 bps over the past four years owing to decreased overheads,

the opening of new state-of-the art facilities while reducing the number of plants by more than

20%, a reduction in its suppler base to less than 30,000 from 100,000, and a 70% reduction

in SKU count. It aims to drive further cost savings through the use of digital tools and

consolidation of IT applications (to improve supply chain efficiency and transportation costs).

These measures are expected to produce incremental gross profit with a portion of it reaching

the bottom line, while the rest will be used for funding advertising and investment.

Joint Ventures Provide ‘Financial Flexibility’

Management recently reiterated its confidence in the joint ventures Mondelez has had in place

since its coffee business combination with D.E. Master Blenders (in 2015) and the company’s

7 January 2020


investment in Keurig Dr. Pepper (KDP). Importantly, management also recently indicated that

these ventures provide ‘financial flexibility.’ We think this means management will monetize

these shares at some point to either finance an accretive acquisition or accelerate share

repurchase. By our estimate of the value of these JVs, the use of proceeds would generate

roughly 6% EPS accretion.

Bear Case

Reinvestment Needs May Continue Through FY20

Management has stated in the past that it plans to reinvest half of its gross profit dollar growth

as a way to spur volume growth to boost the company’s operating leverage (and the other half

drops to the bottom line). However, this is an increasingly competitive market that requires a

higher cost to expand. As a result, it is possible that Mondelez will need to reinvest at a similar

level in FY19. If this is the case, EPS would grow at a mid-single-digit rate, as opposed to a

high single-digit rate.

Shift in Strategy Adds Risk

The shift in strategy might encourage a re-proliferation of SKUs and suppliers that the company

has worked so hard to consolidate over the past five years. If it launches many new products

that consumers simply do not like or extends too far into channels with insufficient demand,

then the company will have a bigger hole to dig itself out of. However, given the size and growth

of the snacking category, we view this as a risk worth taking.

North America Supply Chain Is Still Antiquated

While management recently noted that it is updating the capital and technology in North

America’s antiquated manufacturing facilities, the improvements will take a long time to roll out.

Roughly 40% of its volume is still made on lines that do not provide full reliability. Lack of a

labor contract with the unions in the U.S. has been a significant obstacle to investing in the

footprint and modernizing the lines because the company cannot make improvements until it has

agreements with the unions on the headcount impact. We believe that management and labor

will negotiate a solution that will enable further supply chain restructuring within the timeframe of

the company’s 2022 “Simplify” restructuring plan.

Consumption Rates in Indulgent Categories Could Decline

As consumers increasingly search for healthier snack options, Mondelez’s brands remain

susceptible to the growing backlash against sugar-filled food. We cannot deny that the category

has slowed, with candy currently growing 1-2% versus 3-4% historically while convenience and

drug stores continue to push initiatives to replace candy with healthier snacking options. Our

view is that these categories will hold up surprisingly well because consumers view them as a

relatively small treat in their daily diet (as opposed to a full meal) that provides too much intrinsic

enjoyment to sacrifice. However, a continued transition toward healthier foods remain a

structural risk for the company. Given the sensitivity of the company’s valuation multiple to its

topline growth rate, there is material downside if the company’s growth rate re-rates lower.

Broad International Exposure Could Turn Into a Risk

The global economy is not as safe as it once was. The rise in country nationalism and trade

disputes could present a headwind to a business that derives 70% of its sales from outside the

U.S.

Nomad Foods (Outperform Rating, $26 Target Price)

Valuation

Our $26 price target is based on 11.6x against our forward EBITDA estimate, which is in-line

with U.S. food peers. We expect the multiple to expand assuming the company consummates

an attractive acquisition and as Brexit fears subside. Brexit volatility and pushback from EU

retailers represent the biggest risks to our target price.

7 January 2020


Bull Case

On-Trend Category Leadership

Nomad Foods’ brands compose 14% of frozen food market share on average in Western

European markets, well ahead of branded peers and only second to private label (at roughly

50% share). The company leads advertising spending in its categories on the local level, and its

resurgent volume growth and innovation initiatives position its brands favorably with large

customers such as Tesco and Carrefour. The company’s brand equity and product quality

enable higher price points and corresponding margin-accretive sales for retailers (as compared

to shelf-stable products or private label frozen brands). Sharing best-practices across its

company regionally has created efficiencies in procurement, manufacturing, consumer

marketing, and retailer relationships. We expect Nomad to benefit as shelf space consolidation

toward a two-tier system occurs in the frozen category.

Consistent Organic Sales Growth

We expect organic growth to accelerate to 2.6% in 2020 from 2.0% in 2019 through balanced

pricing and volume growth as the company expands into on-trend ready-meal offerings and

plant-based innovation. This includes the roll-out of its new Veggie Bowls line under the Iglo

brand into five European markets and the launch of Green Cuisine plant-based protein

substitutes in the UK. We have been positively surprised by management’s ability to raise prices

to offset commodity inflation in 2019 with minimal elasticity of demand.

Brexit Fears Overblown

Nomad derives revenues from a variety of European countries including the U.K. (roughly 28%

of sales), Italy (roughly 20% of sales), Germany (roughly 15% of sales), and Sweden (roughly

11% of sales). By our math, a “hard Brexit” with a 20% tariff on imported goods would

represent €30-35 million of higher costs for Nomad, primarily on frozen fish sold in the U.K.

However, a temporary tariff regime published by the U.K. government back in march intends to

give Nomad and other U.K. companies up to 12-months of tariff-free access on their imports in

the event of a “hard Brexit” transition. We think investors underestimate the flexibility this plan

would provide Nomad to either raise prices to offset higher costs or adjust its supply chain to

domestic sourcing. Management has said in the past that it also has the capabilities to fully shift

its manufacturing processes from the EU to the U.K. (and vice versa) to avoid additional costs in

the future.

Potential for Accretive M&A Deal

Chairman of the Board Martin Franklin founded Nomad with the intention of using it as a

platform for acquisitions in the highly fragmented European frozen foods category. As

demonstrated by the value he created for shareholders of Jarden Corporation (which he

eventually sold to Newell), Franklin brings very strong M&A acumen to the boardroom. The

acquisitions of Goodfellas, Iglo, and Aunt Bessie over the past few years all met or exceeded

internal expectations.

Nomad believes there are several candidates in the European frozen foods landscape that

would fit under Nomad’s umbrella. Nomad’s equity offering in 1Q19 and its strong cash flow

have put €750 million of cash on the balance sheet to fuel another acquisition. By our math, a

big transaction like Nestle’s €900M European frozen pizza business would generate as much as

€0.40 of EPS accretion including synergies.

Bear Case

Commodity Cost Exposure

For inputs, Nomad’s product portfolio is heavily dependent on volatile inputs like fish

(composing 40% of sales) and vegetables (composing 30% of sales including meals). It

sources fish through annual contracts from major suppliers and sources peas and spinach

directly from farmers with long-running relationships.

7 January 2020


Collective Purchasing Agreements

European retailers have created purchasing alliances that the manufacturer has to negotiate

with in order to open the door to negotiations at the local level. Retailers in France and Germany

have used these to their advantage for years. Such alliances tend to give the retailers more

leverage to demand favorable trade promotion terms. Nestle recently had trouble with the

Agecore alliance that hurt its sales for a few months until it eventually came to terms. The

recent alliance between Tesco and Carrefour and the consolidation of Asda and Sainsbury may

add to challenges for vendors. That said, we believe Nomad’s scale and pan-European footprint

give it a competitive advantage over small, local players in these negotiations.

Preferred Shares Dilute the Share Count

Holders of Nomad’s Founders Preferred Shares receive an equity dividend when the company’s

share price appreciates over the prior year. For example, we expect the holders to receive a 7M

share dividend for 2019 based on the following calculation: 1) use the last ten trading days of

each year to calculate the stock price appreciation (we estimate 25%), 2) multiply the 25% gain

by a fixed modifier of 20% to get 5%, 3) multiply the 5% by the Preferred Share Count

Equivalent of 140M shares, which is the share count Nomad had when it bought Iglo in 2015.

In 2017 and 2018, these equity dividends increased the share count by 8.7M and171K shares

respectively, representing total dilution to common shareholders of about 5%. In addition, these

preferred shares will be converted into 1.5M common stock on the last day of the seventh

financial year following completion of the Iglo acquisition (2022), representing additional dilution

of about 1% on the horizon.

J.M. Smucker (Underperform Rating, $95 Target Price)

Valuation

Our target price of $95 assumes a forward EV/EBITDA of 10.3x against our FY21 estimate.

This assumes a discount of 20% to packaged food peers, below its historical discount of 8%.

We think the discount is justified because Smucker’s brands face significant competitive

pressures. A rebound in Coffee division margins from lower commodity costs represents the

largest upside risk to our thesis.

Bull-Case

Leadership in Good Categories

Smucker holds leadership positions in several growing categories including coffee (27% of

sales), pet food (36% of sales), and peanut butter and fruit spreads. The portfolio of iconic

brands includes Folgers, Dunkin’ Donuts, Jif, Milk-Bone, Meow Mix and premium pet food

brands such as Natural Balance, Nature’s Recipe and Rachael Ray Nutrish. Rising pet

ownership rates in the U.S., rising per capita consumption of coffee, and the trend toward

“premium-ization” in both categories have fueled the category growth.

Surprisingly Resilient Coffee Profit Margins

Coffee EBIT margins improved 250bps to 32%in FY19 vs. FY18. Management believes that it

can maintain its margins at this level due to the size and scale of its mainstream Folgers brand,

its favorable licensing contract with Dunkin’ and Keurig coffee (which supplies its K-cups), its

procurement expertise in coffee beans, and its competitive advantage over Kraft Heinz, which

has neglected to support Folger’s biggest mainstream competitor, Maxwell House.

The Board Is Taking Steps to Improve Performance

In November 2019, Smucker announced several organizational changes designed to improve its

performance. The company will conduct a candidate search for a newly created Chief Operating

Officer role reporting up to CEO Mark Smucker, a new leader of U.S. retail sales, and a new

leader in the struggling Pet Food division to replace Dave Lemmon. Consistent with the

concerns we expressed in our downgrade of the stock, management intends to hire an

7 January 2020


executive who has pet industry experience. In addition, it announced that CFO Mark Belgya will

retire in May 2020 after a successful tenure.

We like the decision to reinstitute the role of COO at the company and the possibility of bringing

someone with more of an outside perspective into the business. In our view, it shows that the

board understands the severity of the near-term challenges the company faces and is ready to

make necessary changes to improve its operational effectiveness.

Bear-Case

Investments Have Failed to Drive Organic Growth

In 2018, CEO Mark Smucker announced the company’s intention to correct several years of

underinvestment and introduce aggressive new investments to reinvigorate sales growth.

However these efforts failed to improve the top-line trends and led to further downward

revisions to margins and sales forecasts. This raises the possibility that Smucker’s problems

stem from structural issues rather than just lack of effort. Smucker has leadership positions in

two big, dynamic categories (coffee and pet food), but its brands are having trouble keeping up

with changing consumer preferences. In particular, the management team has yet to prove

adept at navigating the pet food category, which it entered through acquisition in 2015.

For example, Smucker’s attempts to premium-ize its Folgers brand (e.g. Folgers 1850 and

Folgers Noir) and introduce portable peanut butter snacks (Jif Power Ups) failed to provide

incremental growth. The Folgers brand in particular has struggled to attract younger consumers

to its franchise. In Pet, the company’s premium brands Nutrish and Natural Balance both face

major setbacks. We view the Pet Food division as the weakest link in the portfolio as

demonstrated by the downward revisions and asset write-downs since Smucker entered the

category in 2015.

Intensifying Competition from Premium Pet Competitors

Nutrish’s recent sales growth rate has been decelerating sharply since General Mills launched

its Blue Buffalo brand into Walmart and expanded its presence in Target. We believe that

increased merchandising support for Blue at these retailers came at the expense of Nutrish and

caused some pet owners to switch brands.

Blue Buffalo has increased the pressure on Nutrish in fiscal 2020 by airing a new advertising

spot which directly compares Blue’s “wholesome” ingredients to Nutrish’s. This marks the first

time that Blue has directly targeted Nutrish in its side-by-side comparisons. If this competition

continues, we think Nutrish’s sales could turn negative by the end of FY20.

We believe that Smucker’s pet brands are also highly vulnerable to the growing trend toward

fresh. Currently, many new private home delivery services provide fresh pet food to clients’

doors. Additionally, shoppers are being exposed to fresh pet food via FreshPet as it has

expanded its distribution in large retailers. As this trend gains additional traction, Smucker may

need to spend more on R&D or M&A to catch up.

Management Keeps Overpromising, Under-Delivering on Sales Growth

One of our pet peeves with Smucker management is that it tends to provide overly audacious

targets for sales growth even though its financial targets for executive compensation use EPS

exclusively. As a result, we have a lot of trouble buying into its claim that it can accelerate its

revenue growth rate to its long-term guidance of 2-3% through innovation, especially when just

about all of the company’s peers have lowered theirs. The enormity of the misses versus

expectations over the years and the lack of accountability in the executive compensation

framework to those sales expectations raises serious concerns about the returns on those

investments. Organic growth has averaged -1% for the past five years and looks to be declining

to -2% in FY 20.

7 January 2020


Margins May Revise Lower

The enormity of the management reshuffle announced in November indicates that Smucker’s

operational challenges are quite profound. With so much change on the horizon and the

company’s sales now firmly in negative territory, we believe that investment spending will need

to increase in FY 21 again and that the “discretionary” spending cuts announced this year will

need to reverse. As a result, we are forecasting an EPS decline in FY 21 compared to FY 20.

Management claimed in November that lowered FY 20 guidance enough to “de-risk” the year.

But in our view, downside risk still exists because the guidance assumes that profits improve to

flat in 2H after declining 3% in the 1H (excluding a gain on sale) despite a tougher year ago

comparison.

Difficult to Find a Talented COO to Help Lead This Business

Finding an executive to accept the COO role won’t be easy. Top-tier executives usually want to

see a clear path to the CEO seat when they come into an organization from the outside –

something that the Smucker family would be unlikely to promise.

7 January 2020


Figure 72: We Estimate That 35% of Smucker’s Portfolio Is Structurally Challenged


Tyson Foods (Outperform Rating, $98 Target Price)

Our $98/share target price reflects a 13.3x P/E against our FY21 EPS estimate of $7.20.

This assumes the stock’s P/E ratio improves versus its 10-year average of 11.2x.

Bull Case

Poised to Benefit from Declines in Global Protein Supplies

As the biggest protein producer in the U.S., the tighter global supplies of pork in the global

market will benefit the company in many ways:

Tyson’s chicken and beef prices will increase due to stronger exports. As China’s pig supply

continues to dwindle, Chinese consumers have begun to shift some of their consumption to

$ SALES BASIS (MM)

Good 2015 2016 2017 2018 L52 Wks

% of Total

2019 Sales 3-Yr CAGR L52 Wks

Dunkin' 459 570 606 645 672 9% 6% 4%

Meow Mix 472 474 471 478 503 7% 2% 6%

Uncrustables 177 199 218 269 303 4% 15% 14%

Nature's Recipe 95 102 180 225 236 3% 32% 6%

Bustelo 100 110 124 136 151 2% 11% 14%

Sahale Snacks 27 32 36 45 48 1% 15% 12%

Sub Total 1,330 1,487 1,635 1,797 1,912 26% 9% 7%

Stable 2015 2016 2017 2018 L52 Wks

% of Total


JIF 768 769 762 762 751 10% -1% -2%

Rachael Ray Nutrish 300 434 556 629 646 9% 14% 5%

Smucker's 577 581 572 566 557 8% -1% -1%

Milk-Bone 404 431 416 408 427 6% 0% 5%

Kibble's N Bits 343 306 305 299 307 4% 0% 3%

Canine Carry Out 127 125 124 124 129 2% 1% 5%

Folgers 1850 0 0 0 30 48 1% 142%

Sub Total 2,519 2,646 2,734 2,817 2,865 39% 3% 3%

Challenged 2015 2016 2017 2018 L52 Wks

% of Total


Folgers 1,920 1,804 1,686 1,597 1,536 21% -5% -5%

Crisco 383 384 328 321 310 4% -7% -4%

9 Lives 281 272 255 253 252 3% -2% -1%

Pup-Peroni 211 211 196 187 190 3% -3% 1%

Other Brands 241 221 197 189 177 2% -7% -7%

Gravy Train 120 120 122 86 81 1% -12% -13%

Milo's Kitchen 69 65 56 53 48 1% -10% -10%

Snausages 23 22 19 15 14 0% -14% -14%

Meaty Bone 21 19 14 12 11 0% -15% -5%

Alley Cat 13 12 9 9 8 0% -10% -6%

Sub Total 3,284 3,129 2,882 2,722 2,627 35% -6% -5%

Total Smucker 7,133 7,262 7,251 7,336 7,403 100% 1% 1%

7 January 2020


chicken and beef. This is a positive for Tyson’s global exports of chicken (about 8-9% of

chicken sales, mainly through leg quarters, thighs, and paws) and beef (about 16% of total

beef), because it increases the likelihood of China importing more protein. Even if China imports

from markets like Western Europe, Brazil, and Australia instead, the U.S. exports will still go

higher because they will need to backfill those supplies.

Tyson’s pork division margins will expand. Even with tariffs in place today, U.S. pork exports

have begun to accelerate. According to USDA data, U.S. pork exports to China have increased

over 100% in volume year-to-date ending October and are expected to continue to accelerate

higher as China’s pork reserves dwindle. Sending more pork volume to China will increase the

value of commodity pork prices and boost margins for Tyson’s Pork division. In addition,

because the Chinese pay a high premium for byproducts of pork processing that are

unappealing in the western market (such as pigs’ feet), margins can increase further.

Tyson’s Keystone chicken business in Asia is also a clear-cut beneficiary. This business

became a leading supplier of Chinese quick-serve restaurant chains by developing access to

high quality domestic chicken suppliers. With China’s domestic breeding flock aging and

Chinese consumers shifting their diets to more chicken, Keystone’s network becomes more

valuable.

The Dark Days of the Latest Chicken Cycle Are Behind Us

It appears the back half of 2018 was the trough of the current chicken cycle. Margins dipped

significantly due to production increases by both Tyson and its competitors as well as a shift in

feature and promotional activity away from chicken and into pork and beef. Since then, both the

supply and demand sides of the industry have shown signs of improvement (albeit very slowly).

The USDA forecasts 3.2% supply growth for the chicken industry domestically in 2020. We

think the supply growth will decelerate in 2021 as chicken processors come to the end of a

cycle of capacity expansion, especially if margins linger below normal levels. In addition, we

believe U.S. chicken exports will accelerate because of ASF’s decimation to China’s hog herd.

This would absorb a significant amount of the production increases that the USDA is

forecasting and drive chicken prices higher as a result.

Chicken Domestic Demand Is Likely to Accelerate

Both retailers and foodservice customers have increased their chicken features this year versus

year-ago levels. Tyson management has said that grocery retailers have been hesitant to

feature pork because they do not feel comfortable committing to promotions for pork products

as ASF continues to shroud the industry with supply uncertainty. Foodservice customers have

responded particularly well. Large foodservice chains like Wendy’s and Burger King, Popeye’s

and Kentucky Fried Chicken have featured chicken sandwiches for the summer and fall

seasons in 2019. McDonald’s is currently testing a chicken sandwich feature at several

locations. If that test is successful and McDonald’s decides to roll out a national launch of this

feature, then it is likely that all chicken prices rise in the near-term, because it is such an

influential buyer in the commodity market.

Bear Case

Chicken Competitors Might Increase Production Too Aggressively

Chicken producers have announced capacity expansion plans equivalent to a 5% increase in

industry capacity from 2017 to 2020. If chicken competitors expand too aggressively to take

advantage of the stronger protein markets, pricing will fall and margins will fail to recover.

Difficult to Predict ASF Outcomes

China’s hog herd has decreased significantly over the past several months stemming from ASF.

However, there is still a tremendous amount of uncertainty. Global protein prices may not

7 January 2020


increase to a degree that investors have hoped for, if China does not import as much protein as

expected.

Management M&A Strategy Has Yet to Yield Positive Returns

Since the start of FY18, the company has spent $3.6B on acquisitions across a wide variety of

segments in the meat industry both domestically and internationally. From an outsider’s

perspective, it is difficult to see a common thread across these transactions or evidence that

they have insulated the chicken business from industry cyclicality.

Tyson Family Controls the Voting Shares

The Tyson Limited Partnership controls 70% of the voting stock of the company. Investors

should recognize that this gives the Tyson family much more influence over the company’s

capital allocation strategy than common shareholders. John Tyson and his aunt Barbara Tyson

are members of the 12-person board. The numerous changes in the CEO seat since 2016

(from Donnie Smith to Tom Hayes to Noel White) is a concern.

Near-Term Margin Erosion in Prepared Foods May Exceed Our Expectation

We estimate that it will take 60-90 days for Tyson’s Prepared Foods businesses to pass

through pricing on products like lunchmeat, hot dogs, frozen sausage, and pizza toppings.

However, if input costs continue to climb higher, it will take longer to fully catch up.

Hiring Another Outsider Raises Questions

Tyson hired Dean Banks from Alphabet for the newly created role of President. The optics of

putting an executive from the technology health care industry into such an important

management role in the livestock industry aren’t too good, in our opinion. The Tyson board has

a history of making risky outside hires that end up not fitting well with Tyson’s distinct corporate

culture and struggling to understand Tyson’s commodity businesses. Recall that Tom Hayes

from Hillshire lasted less than two years as CEO and Wade Miquelon from P&G lasted only two

years as CFO. Getting buy-in from Tyson’s community of employees, livestock suppliers, and

customers will not be an easy task. That said, perhaps we should not underestimate the value

that an elite engineer who has worked on Google’s most influential moonshot projects might

bring to this company.

7 January 2020


Appendix

Figure 73: Organic Sales Growth


Organic Sales % 2012 2013 2014 2015 2016 2017 2018 2019E 2020E

MDLZ 4.5% 3.8% 2.4% 3.4% 1.3% 0.8% 2.4% 3.9% 3.5%

HSY 7.8% 7.9% 3.8% 0.2% 0.9% 0.9% 0.3% 1.8% 1.8%

MKC 6.0% 1.7% 1.7% 5.0% 3.2% 3.7% 2.9% 3.5% 3.5%

GIS 2.7% 2.3% -0.9% 0.5% -2.1% -4.2% 0.3% 0.1% 1.0%

CPB 1.6% 2.2% 0.9% 0.1% -1.4% -1.8% -1.6% 0.4% 0.5%

K 2.5% 0.3% -2.0% 0.3% -0.2% -2.6% 0.0% 1.9% 2.3%

KHC 0.1% 0.0% 0.8% -1.4% 0.3% -0.5% 0.8% -1.4% -0.8%

SJM 6.2% -3.6% -4.9% 1.1% -1.7% 0.5% 0.2% -1.7% -1.0%

CAG 0.6% -0.4% -2.9% -0.4% -3.3% -2.3% -0.1% 0.2% 0.6%

Average 3.4% 1.4% -0.4% 1.0% -0.3% -0.6% 0.6% 1.0% 1.3%

7 January 2020


Figure 74: Raw Materials as a % of COGS


Figure 75: Cash Conversion Cycles


CAG CPB GIS HSY K SJM MDLZ KHC CAG / PF

Total Packaging 19.8% 20.0% 17.0% 13.0% 17.0% 14.0% 20.0% 20.7% 19.3%

Food Costs 51.2% 38.0% 40.0% 55.0% 40.0% 66.0% 55.0% 44.3% 52.6%

Overhead/Labor 29.0% 42.0% 43.0% 32.0% 43.0% 20.0% 25.0% 35.0% 28.1%

100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100%

Food

Flour 0.6% 3.2% 3.6% 0.0% 4.5% 0.0% 0.0% 0.6% 0.9%

Wheat 4.0% 1.2% 1.5% 0.0% 0.0% 0.0% 0.0% 0.0% 3.2%

Durum Wheat 0.0% 1.2%

Soybean Meal 7.0%

Corn 2.2% 0.0% 1.6% 0.0% 2.4% 7.0% 0.0% 0.2% 3.7%

Other Grains 0.0% 0.0% 2.0% 0.0% 2.7% 0.0% 0.0% 2.9% 1.2%

Vegetable Oil 9.8% 0.7% 1.6% 0.0% 1.6% 4.0% 4.4% 6.2% 8.1%

Sugar 0.5% 1.5% 3.2% 5.5% 6.0% 2.0% 15.0% 2.3% 1.2%

HFCS 3.0% 2.0% 3.0% 0.0% 1.1% 0.0% 0.0% 2.6% 2.7%

Cocoa 0.0% 0.5% 2.4% 22.0% 4.3% 0.0% 11.0% 0.0% 0.5%

Coffee 0.0% 0.0% 0.0% 0.0% 0.0% 20.0% 0.0% 2.1% 0.0%

Eggs 0.7% 0.6% 0.4% 0.0% 0.8% 0.0% 0.0% 0.9% 0.6%

Cheese 0.0% 0.0% 0.3% 0.0% 0.0% 0.0% 3.0% 5.1% 0.1%

Milk 1.6% 1.4% 2.5% 11.0% 0.0% 1.0% 1.8% 1.9% 1.6%

Tomatoes 4.1% 9.4% 0.7% 0.0% 0.0% 1.0% 0.0% 2.6% 3.7%

Potatoes 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 1.5% 0.1%

Peanuts 0.0% 0.0% 0.0% 5.5% 1.5% 12.0% 0.0% 0.0% 0.0%

Tree Nuts/Almonds 0.0% 0.2% 0.0% 1.7% 0.4% 0.0% 4.0% 1.0% 0.0%

Pork 6.6% 3.4% 2.3% 0.0% 0.3% 0.0% 0.0% 3.3% 5.4%

Beef 1.8% 1.7% 0.1% 0.0% 0.0% 5.0% 0.0% 1.6% 2.1%

Chicken 3.8% 1.7% 0.5% 0.0% 0.0% 7.0% 0.0% 0.2% 3.5%

Other 12.3% 10.6% 14.2% 9.4% 14.4% 0.0% 15.9% 8.3% 12.5%

Packaging

Paper Packaging 6.9% 4.0% 10.2% 5.2% 11.9% 2.0% 13.0% 9.6% 5.8%

Plastic Packaging 6.9% 4.0% 3.4% 5.2% 3.4% 8.0% 5.0% 5.2% 6.7%

"Metal" Packaging 5.9% 12.0% 3.4% 2.6% 1.7% 4.0% 2.0% 6.0% 6.3%

Overhead

Crude 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%

Energy (Nat Gas) 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%

Labor 18.0% 32.0% 32.0% 20.0% 31.0% 8.0% 13.0% 24.6% 18.7%

Freight 4.0% 3.0% 4.0% 5.0% 5.0% 5.0% 5.0% 3.4% 4.0%

CASH CONV CYCLE 2013 2014 2015 2016 2017 2018 2019 2020

Campbell 57.05 62.42 59.78 52.04 44.87 67.40 54.94 67.97

ConAgra 56.88 54.99 46.51 74.22 36.53 31.71 48.09 26.48

General Mills 33.17 28.21 23.84 8.21 10.02 (0.02) (6.29) (5.58)

Hershey 42.56 57.06 54.19 47.97 48.39 50.75 49.93 48.39

Kellogg 27.32 21.44 7.04 (1.27) (8.67) (8.72) 7.40 18.00

Mondelez 29.04 19.23 1.30 (18.17) (23.82) (32.47) (37.21) (23.33)

Kraft-Heinz 14.53 (16.95) (17.76) (2.02) (18.44) (10.38)

McCormick 85.68 90.83 80.26 80.60 61.04 43.73 43.83 43.86

Smucker 80.70 84.47 101.36 53.45 55.46 45.93 46.79 25.77

Average 51.55 52.33 43.20 31.12 22.90 21.81 21.00 21.24

7 January 2020


Figure 76: Return on Invested Capital


ROIC 2013 2014 2015 2016 2017 2018 2019 2020

Campbell 16.2% 17.4% 17.3% 20.7% 20.7% 8.1% 10.0% 13.7%

ConAgra 7.2% 7.9% 8.8% 8.5% 11.9% 11.0% 6.1% 7.4%

General Mills 12.8% 12.4% 12.9% 14.1% 14.0% 8.4% 10.1% 10.4%

Hershey 36.7% 29.4% 31.6% 30.6% 32.9% 24.6% 26.3% 27.4%

Kellogg 14.5% 15.8% 15.0% 16.0% 13.2% 13.4% 12.5% 11.8%

Mondelez 7.7% 8.6% 6.6% 7.4% 7.4% 7.9% 7.6% 7.7%

Kraft 4.8% 6.1% 5.1% 5.9% 5.1% 4.7%

B&G Foods 7.4% 6.8% 4.8% 6.4% 6.5% 6.0% 5.8% 5.7%

McCormick 13.9% 14.8% 15.3% 16.4% 7.8% 9.6% 11.1% 11.5%

Smucker 8.6% 8.9% 5.4% 7.8% 8.3% 8.2% 8.1% 7.9%

Average 13.9% 13.8% 12.7% 13.9% 12.0% 10.2% 10.4% 10.9%

7 J

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oods P

revie

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Figure 77: Packaged Food Trading Comparisons


Company Credit Suisse Price Market Enterprise Performance EV / EBITDA Net Debt / Payout

Company Rating TP 01/03 Cap Value YTD L52 FCF Div FY 2019 FY 2020 CY 2019 CY 2020 CY 2019 CY 2020 EBITDA Ratio

Agribusiness:

Archer Daniels N $40 $46.02 $25,619 $34,121 12.3% 12.9% -1.7% 3.0% $2.60 $2.95 17.7x 15.6x 11.4x 10.3x 2.8x 54%

Tyson O $98 $90.58 $33,096 $44,114 69.6% 66.2% 3.8% 1.8% $5.46 $6.50 15.8x 13.9x 10.4x 9.2x 2.7x 29%

Hormel N $38 $44.25 $23,662 $23,224 3.7% 6.2% 2.8% 2.1% $1.73 $1.73 25.6x 25.7x 17.2x 16.9x (0.3)x 54%

Sanderson Farms O $197 $175.16 $3,894 $3,808 76.4% 74.1% -1.1% 0.7% $2.41 $9.46 48.9x 18.5x 15.7x 8.0x (0.4)x 53%

Bunge O $65 $57.94 $8,208 $12,912 8.4% 8.5% -19.1% 3.5% $3.60 $3.37 16.1x 17.2x 8.2x 8.4x 3.0x 56%

Ingredion N $77 $93.70 $6,256 $7,988 2.5% 1.8% 4.6% 2.7% $6.50 $6.30 14.4x 14.9x 8.6x 8.7x 1.9x 38%

Average 28.8% 28.3% -1.8% 2.3% 23.1x 17.6x 11.9x 10.3x 1.6x 47%

SMID Food Producers:

McCormick N $160 $170.20 $20,842 $24,649 22.2% 24.9% 2.8% 1.3% $5.34 $5.78 31.6x 29.4x 21.2x 20.0x 3.3x 43%

Nomad Foods O $26 $22.25 $4,327 $5,445 33.1% 30.0% 8.4% 0.0% $1.38 $1.46 14.4x 15.2x 12.7x 10.6x 2.6x 0%

TreeHouse N $55 $47.84 $2,689 $4,646 (5.7)% (6.3)% 7.1% 0.0% $2.36 $2.44 20.2x 19.6x 9.9x 9.7x 4.2x 0%

B&G Foods U $14 $17.62 $1,128 $3,000 (39.1)% (38.5)% -0.2% 11.0% $1.64 $1.56 10.7x 11.3x 10.0x 10.2x 6.2x 118%

Freshpet N $58 $60.63 $2,188 $2,193 88.5% 90.2% -0.3% 0.0% $0.03 $0.63 1952.8x 95.7x 71.9x 40.8x 0.2x 0%

Beyond Meat N $115 $75.41 $4,639 $4,454 NA NA -0.5% 0.0% $0.01 $0.20 5084.3x 382.6x 195.7x 156.9x (8.2)x 0%

Average ex-BYND 19.8% 20.1% 3.6% 2.5% 406.0x 34.3x 25.1x 18.3x 3.3x 32%

Large Cap Packaged Food:

Kraft Heinz U $27 $31.24 $38,149 $66,086 (27.4)% (27.9)% 6.1% 5.1% $2.82 $2.45 11.1x 12.7x 10.9x 11.4x 4.6x 57%

Mondelez O $60 $54.24 $78,096 $95,843 35.5% 36.5% 3.6% 1.9% $2.47 $2.67 21.9x 20.3x 17.0x 17.7x 3.4x 42%

General Mills N $56 $51.94 $31,414 $45,454 33.4% 33.1% 7.2% 4.4% $3.22 $3.38 15.7x 15.4x 12.6x 12.3x 3.9x 71%

Kellogg O $78 $68.00 $23,163 $30,719 19.3% 19.8% 2.4% 3.4% $3.91 $3.97 17.4x 17.1x 13.5x 13.6x 3.3x 58%

Hershey N $155 $145.26 $30,348 $34,218 35.5% 36.7% 4.8% 2.1% $5.74 $6.17 25.3x 23.5x 17.1x 16.3x 1.9x 52%

Conagra N $32 $33.34 $16,223 $26,468 56.1% 54.6% 5.1% 2.5% $2.02 $2.08 16.2x 16.0x 13.7x 12.8x 5.7x 42%

Campbell Soup U $43 $48.43 $14,609 $23,177 46.8% 48.3% 6.8% 2.9% $2.30 $2.54 20.2x 19.1x 13.8x 14.1x 5.0x 62%

Smucker U $95 $102.29 $11,667 $17,476 9.4% 8.1% 6.7% 3.4% $8.29 $8.07 12.6x 12.7x 10.6x 10.8x 3.4x 42%

Average 26.1% 26.2% 5.4% 3.2% 17.5x 17.1x 13.6x 13.6x 3.9x 53%

Average U.S. Food * 16.4x 16.1x 12.8x 12.7x 4.3x 55%

High Ex-BYND 88.5% 90.2% 8.4% 11.0% 1952.8x 71.9x 40.8x 6.2x 118%

Average Ex- BYND 25.3% 25.2% 2.6% 2.7% 121.5x 16.1x 13.8x 3.0x 46%

Median Ex-BYND 22.2% 24.9% 3.8% 2.5% 17.4x 12.7x 11.4x 3.3x 52%

Low Ex-BYND (39.1)% (38.5)% -19.1% 0.0% 10.7x 8.2x 8.0x (0.4)x 0%

S&P 500 29.0% 32.1% 18.36 20.12

Consumer Staples Select SPDR 22.8% 24.3%

* U.S. Food average includes SJM, CPB, CAG, K, GIS, MKC, PF. Both GIS and MDLZ include equity investments in EBITDA. NOMD EBITDA raised 4% due to accounting change.

Yield P / EProjected EPS

7 January 2020


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Companies Mentioned (Price as of 06-Jan-2020) Alphabet (GOOGL.OQ, $1361.52) Amazon com Inc. (AMZN.OQ, $1874.97) American Express Co. (AXP.N, $124.6) Anheuser-Busch InBev (ABI.BR, €74.27) Apple Inc (AAPL.OQ, $297.43) B&G Foods Inc - Class A (BGS.N, $17.62) Bayer (BAYRY.PK, $36.8325) Beyond Meat (BYND.OQ, $75.41) Campbell Soup Company (CPB.N, $48.43) Church & Dwight Co, Inc. (CHD.N, $70.27) Colgate-Palmolive Company (CL.N, $68.02) Conagra Brands (CAG.N, $33.34) General Mills (GIS.N, $51.94) Hormel Foods (HRL.N, $44.25) J.M. Smucker Co. (SJM.N, $102.29) Kellogg Company (K.N, $68.0) Kimberly-Clark Corporation (KMB.N, $135.79) McCormick & Company (MKC.N, $170.2) Microsoft (MSFT.OQ, $158.62) Molson Coors Brewing Company (TAP.N, $53.38) Mondelez (MDLZ.OQ, $54.24) Monster Beverage Corporation (MNST.OQ, $63.28) Nestle (NESN.S, SFr106.26) Netflix Inc. (NFLX.OQ, $325.9) Nomad Foods (NOMD.N, $22.25) PepsiCo (PEP.OQ, $135.63) Procter & Gamble (PG.N, $122.58) Sanderson Farms (SAFM.OQ, $175.16) Target Corporation (TGT.N, $124.76) The Clorox Company (CLX.N, $152.91) The Coca-Cola Company (KO.N, $54.69) The Estee Lauder Companies Inc. (EL.N, $204.7) The Hershey Company (HSY.N, $145.26) The Kraft Heinz Company (KHC.OQ, $31.24) The Kroger Co. (KR.N, $28.7) The Walt Disney Company (DIS.N, $146.5) Tyson Foods (TSN.N, $90.58) Walmart Inc. (WMT.N, $117.89)

Disclosure Appendix

Analyst Certification

I, Robert Moskow, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

As of December 10, 2012 Analysts’ stock rating are defined as follows:

Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European (excluding Turkey) ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the an alyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin America, Turkey and Asia (excluding Japan and Australia), stock ratings are based on a stock’s total return relative to the average to tal return of the relevant country or regional benchmark (India - S&P BSE Sensex Index); prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’ s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 M ay 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products.

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Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation:

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Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may c over multiple sectors.

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Global Ratings Distribution

Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 48% (31% banking clients)

Neutral/Hold* 38% (26% banking clients)

Underperform/Sell* 13% (22% banking clients)

Restricted 2%

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For Credit Suisse's position on the issue, please see The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities See the Companies Mentioned section for full company names Credit Suisse currently has, or had within the past 12 months, the following as investment banking client(s): GIS.N, HRL.N, KHC.OQ, PEP.OQ, KO.N, WMT.N, BGS.N, BYND.OQ, CPB.N, MDLZ.OQ, MKC.N, NOMD.N, AMZN.OQ, DIS.N, GOOGL.OQ, MSFT.OQ, NESN.S, AXP.N Credit Suisse provided investment banking services to the subject company (GIS.N, HRL.N, KHC.OQ, PEP.OQ, KO.N, WMT.N, BGS.N, BYND.OQ, CPB.N, MDLZ.OQ, MKC.N, NOMD.N, AMZN.OQ, DIS.N, GOOGL.OQ, MSFT.OQ, NESN.S, AXP.N) within the past 12 months. Within the last 12 months, Credit Suisse has received compensation for non-investment banking services or products from the following issuer(s): KHC.OQ, KO.N, WMT.N, CPB.N, MDLZ.OQ, AMZN.OQ, DIS.N, AAPL.OQ, GOOGL.OQ, MSFT.OQ Credit Suisse has managed or co-managed a public offering of securities for the subject company (KHC.OQ, KO.N, WMT.N, BGS.N, BYND.OQ, MDLZ.OQ, NOMD.N, AXP.N) within the past 12 months. Within the past 12 months, Credit Suisse has received compensation for investment banking services from the following issuer(s): GIS.N, HRL.N, KHC.OQ, PEP.OQ, KO.N, WMT.N, BGS.N, BYND.OQ, CPB.N, MDLZ.OQ, NOMD.N, AMZN.OQ, DIS.N, GOOGL.OQ, MSFT.OQ, NESN.S, AXP.N Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (GIS.N, HRL.N, SJM.N, KHC.OQ, KO.N, WMT.N, BGS.N, CAG.N, CPB.N, HSY.N, K.N, KR.N, MDLZ.OQ, MKC.N, TSN.N, MNST.OQ, NOMD.N, CL.N, AMZN.OQ, DIS.N, AAPL.OQ, GOOGL.OQ, MSFT.OQ, NESN.S, AXP.N) within the next 3 months. Credit Suisse currently has, or had within the past 12 months, the following issuer(s) as client(s), and the services provided were non-investment-banking, securities-related: KHC.OQ, MDLZ.OQ, AMZN.OQ, DIS.N, AAPL.OQ, GOOGL.OQ, MSFT.OQ Credit Suisse currently has, or had within the past 12 months, the following issuer(s) as client(s), and the services provided were non-investment-banking, non securities-related: KO.N, WMT.N, CPB.N, MDLZ.OQ, AMZN.OQ, DIS.N, GOOGL.OQ Credit Suisse or a member of the Credit Suisse Group is a market maker or liquidity provider in the securities of the following subject issuer(s): GOOGL.OQ, AMZN.OQ, AXP.N, ABI.BR, AAPL.OQ, BGS.N, BYND.OQ, CPB.N, CHD.N, CL.N, CAG.N, GIS.N, HRL.N, SJM.N, K.N, MKC.N, MSFT.OQ, TAP.N, MDLZ.OQ, MNST.OQ, NESN.S, NFLX.OQ, NOMD.N, PEP.OQ, PG.N, SAFM.OQ, TGT.N, CLX.N, KO.N, EL.N, HSY.N, KHC.OQ, KR.N, DIS.N, TSN.N, WMT.N A member of the Credit Suisse Group is party to an agreement with, or may have provided services set out in sections A and B of Annex I of Directive 2014/65/EU of the European Parliament and Council ("MiFID Services") to, the subject issuer (GIS.N, HRL.N, KHC.OQ, PEP.OQ, KO.N, WMT.N, BGS.N, BYND.OQ, CPB.N, MDLZ.OQ, MKC.N, NOMD.N, AMZN.OQ, DIS.N, GOOGL.OQ, MSFT.OQ, NESN.S, AXP.N) within the past 12 months. As of the date of this report, Credit Suisse beneficially own 1% or more of a class of common equity securities of (BYND.OQ, CAG.N, NESN.S). Credit Suisse beneficially holds >0.5% long position of the total issued share capital of the subject company (BYND.OQ).

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Credit Suisse is acting as an agent in relation to Nestle’s (NESN.S) ongoing share buy-back program. Credit Suisse is acting as Financial advisor to Nestlé in relation to disposal of its U.S ice cream business to Froneri

For date and time of production, dissemination and history of recommendation for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to the link: https://rave.credit-suisse.com/disclosures/view/report?i=480873&v=1enao0frb6ekjw2iogtc90555 .

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Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.credit-suisse.com/sites/disclaimers-ib/en/canada-research-policy.html. Investors should note that income from such securities and other financial instruments, if any, may fluctuate and that price or value of such securities and instruments may rise or fall and, in some cases, investors may lose their entire principal investment. This research report is authored by: Credit Suisse Securities (USA) LLC ........................................................... Robert Moskow ; Matthew Parker ; Jacob Nivasch

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