A Solid Investor Hedge Against a Possible Market Turnaround

We all like to stock our portfolio with some high-growth/high-potential names along with some more conservative investments to sleep well at night. With the stock market now approaching the 14-month point of a remarkable bull run, it may be time to add another conservative name to the mix. ConAgra Foods (NYSE: CAG), which makes prepared consumer foods (two-thirds of sales) and supplies major food service providers such as schools and hospitals (one-third of sales), has built a nice recipe for growth.

To be sure, food consumption grows at a fairly slow rate. To boost the bottom line, a food service company needs a mix of product innovation, savvy acquisitions, and continuing opportunities for cost reductions, all of which can yield steady profit margin gains and a growing bottom line. And that’s the ConAgra playbook. The company owns such brands as Hunts, Orville Redenbacher, Chef Boyardee, Hebrew National and Peter Pan.

In recent years, ConAgra has beefed up its exposure to the frozen food aisle with brands such as Marie Callender, Healthy Choice and Banquet. But frozen foods represent a big trade-off for consumers. Microwaveable meals are fast to prepare, but can heat unevenly. Oven-cooked meals cook more evenly, but take too long for some consumers. The solution: ConAgra has developed “smart tray” technology that helps to ensure that microwaveable food is cooked thoroughly and evenly.

Look for the technology to be first rolled out with the Marie Callender brand later this year, with other brands to follow next year. Those products should garner a decent price premium over traditional items. On the value end, ConAgra is rolling out frozen fruit pies to augment the more dowdy frozen pot pies, pricing them at $0.99 apiece. ConAgra has already picked up 100 basis points of market share during the past year in frozen foods, and recent data points from A.C. Nielson indicate that market share gains will continue this year as well.

Of course, investors are more focused on the financial statements than the store shelves and management seems to be paying better attention here as well. The company’s earnings before interest, tax, depreciation and amortization (EBITDA) margin is steadily expanding, from 11.3% in fiscal 2008 (ended May 31,2008) to an expected 13.7% this fiscal year, which ends next month. Management believes that the EBITDA margin can hit 15% by fiscal 2012.

The steady gains in profit margins, coupled with modest sales gains, should boost per-share profits around +15% in fiscal 2010 from the previous year, to around $1.75. In the next few years, +8% to +10% profit gains appear to be a reasonable target. That profit growth is boosting the balance sheet, as the company is generating more than $1 billion in cash flow every year. As debt gets paid down, more money is left for share buybacks and acquisitions. The company is in the midst of a current $500 million share buyback, which could reduce the share count by about 4%. If no compelling acquisition opportunities emerge during the next year, that share buyback is likely to be extended. The company could also seek to boost its dividend, which currently yields about 3.3%.

As with many stocks, shares of ConAgra have lifted up from multi-year lows seen last spring. But shares have been roughly flat during the past five years. And that’s understandable because the company’s annual results had been fairly uninspiring in recent years. But with management now working to bring more innovation to its products, boost market share, expand profit margins, and return more cash to investors, the stock may finally break above its five-year trading range. Assuming shares move toward the broader market multiple, they could broach the $30 mark in coming quarters. That’s good for a moderate gain of about +22% from current levels. Then again, shares are likely to hold their own better than many recent strong gainers if we get another market swoon.