Conagra Brands’ Cash Flow Increases The Safety Of Its Dividend Yield

Recap from January’s Picks

On a price return basis, the Safest Dividend Yields Model Portfolio (+0.1%) outperformed the S&P 500 (0.0%) by 0.1% from January 20, 2022 through February 16, 2022. On a total return basis, the Model Portfolio (+0.4%) outperformed the S&P 500 (0.0%) by 0.4% over the same time. The best performing large cap stock was up 15% and the best performing small cap stock was up 5%. Overall, 8 out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from January 20, 2022 through February 16, 2022.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because I know they have the cash to support the dividend. I think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.

Featured Stock for February: Conagra Brands Inc.
CAG

Conagra Brands, Inc. (CAG) is the featured stock in February’s Safest Dividend Yields Model Portfolio.

Conagra grew revenue and net operating profit after-tax (NOPAT) by 12% and 22% compounded annually, respectively, from fiscal 2018 (FYE is 5/30) to fiscal 2021. Conagra’s rising NOPAT drove economic earnings from $290 million to $929 million over the same time. Over the trailing twelve months (TTM), economic earnings are $693 million, which, while down from fiscal 2021, are still higher than all but four years since 1998.

Figure 1: Conagra’s Economic Earnings Since Fiscal 2018

Free Cash Flow Supports Dividend Payments

Conagra has paid dividends every year since fiscal 1990 and increased its dividend from $0.90/share in fiscal 2017 to $1.04/share in fiscal 2021. The current regular quarterly dividend, when annualized, provides a 3.5% dividend yield.

In fiscal 2019, Conagra acquired Pinnacle Foods Inc. for ~$10.9 billion, which contributed to the firm’s -$10.5 billion free cash flow (FCF) that year. Excluding fiscal 2019, Conagra’s FCF has exceeded its dividend payment every year. As FCF has improved from $562 million in fiscal 2018 (the year before the acquisition) to $968 million TTM, Conagra easily generates enough cash to support raising its dividend. In fiscal 2020 and 2021, Conagra generated $3.3 billion (19% of current market cap) in FCF while paying $888 million in dividends.

Figure 2: Conagra’s FCF vs. Dividends Since Fiscal 2017

Companies with strong FCF provide higher quality dividend yields because I know the firm has the cash to support its dividend. On the other hand, dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.

Conagra Is Undervalued

At its current price of $36/share, Conagra has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects Conagra’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that Conagra grew NOPAT by 5% compounded annually over the past decade.

Even if Conagra’s NOPAT margin falls to 11% (five-year low, compared to 12% TTM), and the company’s NOPAT falls by 2% compounded annually over the next decade, the stock is worth $69/share today – a 92% upside. See the math behind this reverse DCF scenario. In this scenario, Conagra’s NOPAT in fiscal 2031 is 3% below TTM levels. Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Conagra’s 10-K and 10-Qs:

Income Statement: I made $813 million in adjustments with a net effect of removing $227 million in non-operating expenses (2% of revenue).

Balance Sheet: I made $6.1 billion in adjustments to calculate invested capital with a net increase of $5.4 billion. The most notable adjustment was $4.2 billion (22% of reported net assets) in asset write-downs.

Valuation: I made $12.7 billion in adjustments with a net effect of reducing shareholder value by $12.4 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $1.2 billion in deferred tax liabilities. This adjustment represents 7% of Conagra’s market value.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.