The Moat Show Ep. 5: Campbell Soup Company with Morningstar's Erin Lash

On The Moat Show, we uncover the companies with economic moats, one stock at a time, by bringing on analysts from Morningstar to share their in-depth insights with you.

The views and opinions expressed herein are those Erin Lash of Morningstar as of 10/3/2023 and are not intended as financial advice, a recommendation to buy or sell any securities mentioned, or any call to action. Actual future performance of any securities mentioned is unknown. Certain statements may constitute forecasts, projections, or other forward-looking statements which are valid as of the recording date, for illustrative purposes only, subject to change without notice, and do not necessarily reflect those of VanEck or its employees.

CHELSEA: For today's Moat Show episode, we're covering Campbell Soup Company and are lucky to have on Erin Lash, Morningstar's director of consumer equity research in the midst of this very busy earnings season. So welcome, Erin.

ERIN: Thank you for having me.

CHELSEA: Erin, are you able to provide a quick historical overview of Campbell's as a company? It's been around for 150 years now, so I'm sure it's evolved a little bit.

ERIN: Yeah, absolutely. You're absolutely right. It started in 1869, and over that time, while it continued to build out its portfolio of soup offerings, it also hungered for acquisitions. And so in 1915 it acquired Franco-American. In 1948 it acquired V8. And then in 1961, it made an approach into the snacking aisle with the acquisition of Pepperidge Farm. The pursuit of acquisitions continued, most notably under a former CEO, Denise Morrison, in the 2000s as she tried to expand the portfolio into fresh and organic to counter some of the retreat from center store categories that we had been seeing. But the most notable acquisition of late was really the acquisition in 2018 of Snyder's Lance's snacking portfolio, and that really catapulted their presence in the snacking aisle and diminished the contribution from Soup, which was it was quite challenging given its namesake and its long legacy in that category.

CHELSEA: What is your strategic view on Campbell's current position in its market and how has the company really adapted to the changes within the CPG, or Consumer Packaged Goods sector, to perhaps stay relevant?

ERIN: So as I alluded to, you know, Campbell had built out its portfolio in Fresh in Organics. That expansion really soured and they retreated from those efforts selling their international business, focusing exclusively on North America, and then exclusively focusing as well on simple meals, and in the soup aisle, Campbell remains the leader far and away. They control more than half of the market, far outpacing the low double digits that General Mills holds, as well as the mid-teens share that private label maintains in the category. So far and away the dominant share. Conversely, in snacking, which makes up about half of their portfolio now, they are still a relatively small player in the space. Obviously, that's a category that's dominated by the likes of Pepsi as well as Kilonova, the former North American snacking arm of Kellogg, as well as Mondelez. And so while they have made inroads in terms of the contribution to their overall portfolio, they’re still not a leading player in the space and still have share gains to be had across tortilla chips, potato chips, and other salty snacks. As it relates to, you know, expanding and adapting to the evolving consumer trends that we see, innovation is really at the heart of that. And making sure that not just bringing new products to market, but doing so in a timely fashion. And by all accounts, that's an area that has plagued packaged food companies and consumer product companies more broadly for years, and one which their current CEO, Mark Clouse, has been working to rectify since he took the helm back in 2019. Those efforts have involved a few different initiatives. Number one, making sure that the R&D function was more dedicated across the organization as opposed to being diffused and not very integral Secondarily, seeking out external partnerships and really making sure that they have access to data and analytics as it pertains to consumer shopping trends to make sure that the products that they're bringing to market are being done and aligning with those evolving consumer trends. And then finally, not waiting so long to bring a product to market. So developing a product, bringing it to market. Getting quick feedback from consumers. Re-jiggering the product to align with consumer trends and then rolling it out on a larger scale. It had previously taken packaged food companies anywhere from 18 to 24 months to get a product from concept to shelf and trends are evolving much quicker. And so this test and learn approach should materially cut down the time it takes for Campbell to get a product to market.

COULTER: Wow, that's really interesting, Erin. I mean, just to realize that snacking foods, you know, account for you know, I think you mentioned about half of Campbell's revenue now. And, I guess one question I have on that is sort of how, you know, how often and how fast these trends change. How does Campbell balance, you know, the trend versus demand? You know, do you see sometimes I feel like there might be trendy things out there, but that might not necessarily mean that there's demand. So can you speak a little bit to kind of how Campbell thinks about that?

ERIN: Yeah, absolutely. It's a great question. For one, Health and wellness has been a trend for quite some time, right. And consumers say that they want healthier products, but they haven't shown that they're willing to sacrifice taste for a healthier product. That came to light for Campbell’s Soup 15 to 20 years ago. The company brought to market lower sodium soup and consumers balked because they associated a product, a soup product that had less sodium as one that tasted horrible potentially without even trying it. And so what consumer products companies, including Campbell's Soup, have been forced to do is is to, number one, as it pertains to health and wellness in particular, but is make their products healthier without telling consumers. So doing so in smaller increments, not shining a light on those efforts. so the other factor as it pertains to innovation and ensuring that it aligns with consumer trends is making sure that you're not putting all of your eggs in one basket. So while health and wellness has shown to be a trend, there are still consumers that want to indulge. And making sure that Campbell is innovating behind, for instance, its core soup lineup as opposed to those products that are fresher or healthier. Like “Well Yes!.” Is one that they abandoned for some time and that alienated their core consumer who drive the bulk of their soup sales. And so continuing to innovate not only behind new flavor profiles, but different packaging formats is one way to keep consumers engaged and connected to the brand and ensure that they are balancing those efforts from an innovation perspective.

COULTER: Wow. So, there's clearly a lot of factors that go into, bringing products to the market and ensuring that consumers understand that, you know, and it is what they want and what they demand. So very interesting. I guess shifting gears just a little bit, kind of looking at, Campbell's kind of evaluation and in essence, I know Campbell Soup, the share price recently has sort of been under some pressure, you know, the last few months. And, you know, last I looked the company's share value was down, you know, almost 30%, you know, in the last six months. So what do you think is leading to this pressure? Do you think is warranted or, you know, is there possibly a valuation opportunity in the long term here?

ERIN: Yeah, we definitely view, where shares stand is an opportunity. And Campbell isn't alone in terms of the retreat that they've seen. Most of the packaged food names that I personally cover have now trade or look more attractive or the ones that didn't look attractive previously now look more fairly valued. And we think that there's a couple of factors behind that. Number one, the resilience of the consumer and the extent to which volumes continue to hold up, particularly in North America after the sheer amount of robust price increases that companies have put through over the last couple of years. while volumes have been fairly resilient up till now, we think that there's a concern that those volumes will fall off a cliff and that will ultimately impair the top line trajectory for a number of these packaged food manufacturers that have been quit heated over the last several quarters. That's compounded by the fact that over the last few years, basically since the pandemic took hold, promotional spending has primarily laid idle. You think about the supply demand imbalances that ensued during COVID and the subsequent time horizon, and there hasn't been the ability, even for consumer products companies to put through promotions because, you know, it would be disastrous for your brand if you were to promote a particular product and then the consumer show up at the grocery store and it not be on shelf. That leads to frustration for the consumer as well as for the retail partner. There is a concern from our vantage point that with any volume declines that we see that firms could resort to promoting to chase market share. And that not only is probably a short term mechanism to it to beef up their share position, but one in which was like is likely to restrain profitability and margins. So what we think and what firms have shown up to this point, including Campbell Soup, is the ability and the desire and the understanding of the importance of continuing to invest behind innovation, but also marketing. Even new products and those which align with consumer trends can fail if consumers aren't aware of them. So to the extent that Campbell and others continue to prioritize funneling resources towards R&D, towards marketing, we think that they can buck the trend that's weighing on shares and that should provide an opportunity to continue to realize modest growth while ensuring that profitability proves durable.

CHELSEA: Erin, are there any key catalysts that you're watching that might change your view or pose a risk to your view on the stock?

ERIN: Absolutely. You know, from out vantage point, if there if we saw management opt to prioritize near-term cash flows and profitability at the expense of investing in the business, whether that be fixed assets and capabilities, increased automation in their manufacturing plans or just as it pertains to the brand spending that we've talked about that would lead us to take a more negative view on the company and its competitive position. And with that, likely a more sour take as it pertains to the valuation. To the extent that the firm continues to really put its money where its mouth is in terms of investing to support the long term health of the business, we think shares look attractive at current levels.

COULTER: We're seeing a lot of discussion around inflation and escalating costs. And that's been, you know, a primary, you know, a point of concern for many investors over the last year or so. So can you speak a little bit about kind of how has that impacted Campbell or the broader food production industry in general? Have they been affected by these, you know, increasing expenses?

ERIN: Yes, they absolutely have been. And those have been in the form of commodities, packaging, transportation, as well as labor and even though commodities or certain commodities have come off recent highs, there is still inflation in various aspects. Obviously, fuel remains high and wage inflation is still a persistent headwind for a number of these operators. And the result of that has been pressure as it pertains to margins both the gross and operating margin lines, not to counter those pressures that these firms are facing, Campbell included. We've seen firms take it really a multi-faceted approach. Obviously, there's been, you know, several rounds of pricing that have been put through. I wouldn't say that any of these companies have raised prices to the full extent of the commodity cost pressures that they're seeing, but that has been one lever that they have tackled. Secondarily, we've seen firms, including Campbell Soup, scour their businesses for inefficiencies. So extracting unnecessary costs, driving automation to the extent possible and reducing discretionary expenses. So obviously, a number of firms have cut back on unnecessary travel as it pertains to work or some of the fringe spending that had been occurring pre-pandemic. And then finally, we've seen more emphasis on altering price packs. So making sure that the offering that they're bringing to the shelf aligns with what consumers can spend. So obviously be a consumer that's cash constrained may seek one of two different options. They may opt and they may have less disposable income to spend on a daily or weekly basis. And so having a smaller product that has a lower absolute price point may be more desirable for others. Shopping at mass merchants or club stores where they can buy in bulk for a lower overall unit price might be more suitable to their financial position. And so each of those areas can provide margin benefits depending on the strategy. But ultimately, consumer products companies want to make sure that their products are placed where consumers are shopping. But as it pertains to, you know, the escalating costs, I would say that there have been a number of facets that they have pursued, all of which have helped blunt the hit. And I would say that, you know, as it pertains to the pricing mechanism, the extent to which retailers have built out their private label exposure over the past decade or so helps firms raise prices. Leading brands raise prices because of the degree to which retailers are feeling the pressure on their own financial statements as well. And they need leading brands like Campbell Soup to raise prices before they can because there's no incentive for them to narrow that price gap and make their products be perceived as offering less value.

COULTER: Great. Extremely interesting. It seems like, you know, as any company, there's a lot of factors in today's market and a lot of uncertainties that are impacting, you know, companies of all different types. But it seems like, you know, Campbell, soups new this kind of got a foothold within this particular sector so and possibly good things to come. So but with that that will conclude today's episode. So thank you, Erin. We appreciate you sharing your time and your insights with here with us here today. So it's very much appreciated.

CHELSEA: Thanks, Erin!

ERIN: Yeah, thank you for having me.

COULTER: And thank you to all of our viewers as well. See you next time on The Moat Show.