Saturday, March 25, 2006

Conagra -- Able, Willing, and Ready -- Not

Time does not permit me to comment on many individual stocks, but I was recently asked about my outlook on Conagra - CAG and there are elements of the Conagra story that I would like to expound upon, so here goes. We operate on the investment thesis of Able, Willing, and Ready. Because dividends are not guaranteed, answering the Able question tells you what level of risk you are assuming. I learned the hard way many years ago that a high-dividend yield is just another way of saying high risk. Many people who load up on high yield dividend stocks would not buy a junk bond because of its perceived high risk, but from a strict financial perspective, the junk bond has less risk that the high yield stock. Having said this, CAG would seem to pass this test easily, with an A- quality rating from S&P. But we caution, S&P's quality rating is entirely looking backwards, so we move on. Quantifying the Willingness of the company to pay a dividend commensurate with its success is easy. Just look at a table that shows the growth of earnings versus dividends. If they are, indeed, both growing at similar rates, it passes. If the dividend, which is the investor's cut of the annual profits, is traversing a trend that is not related to earnings, beware. Dividend growth that is only a fraction of earnings growth is a complete non starter, but dividend growth far in excess of earnings growth is also a signal that the company might be a little too "willing," shall we say. Sort of like the "painted lady." If she's over-painting, what's she hiding? CAG begins to fade a bit here in its attractiveness. Its dividend has been growing far more rapidly than its earnings. Indeed, before CAG recently cut its dividend, they were paying out nearly 80% of their earnings in dividends. Except for REITs and Master Limited Partnerships, an 80% payout is "unreal," and falls into the category of "its just a matter of time." The Ready stage is about valuation and fundamentals. In CAG's case we don't need to go very far. A look at their earnings over the last 5 years shows flat earnings growth and decreasing sales growth. As a practical matter, a dividend with no visible means of support is really risky business and spins us back to Able. CAG is a solid business, but even a cursory look through the lens of Able, Willing, and Ready tells us that the current business trends are not working and a shake up is coming. In shake ups, the first thing to go is the dividend. Why? Because dividends are real money that is going out the door; while the necessity for a shakeup is evidence, that the quality of the money coming in the door "ain't real good." It may appear like I'm hindsighting CAG, but we have watched its lack of progress for years. I think we may have owned it many years ago, but sold it for many of the reasons identified above. I don't own the stock. This is not a recommendation. Please don't act on anything I have said here. My purpose in discussing this company is to offer insights into the Rising Dividend Investing strategy that we use at our firm. Blessings,