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Lamb Weston Holdings Inc LW

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A Poor-Quality Potato Crop Should Sour Lamb Weston’s Profit Margins; Shares Appear Fairly Valued

Analyst Note

| Rebecca Scheuneman, CFA |

In our view, the most significant news from narrow-moat Lamb Weston’s August-ended fiscal 2022 first-quarter report was that the new potato crop (to be used from the third quarter of fiscal 2022 through the second quarter of fiscal 2023) is of poor quality because of the extremely hot summer, which will materially elevate processing costs. As a result, management lowered its gross margin forecast for the second half of fiscal 2022 from 25%-26% to 17%-21%. In addition, Lamb Weston is experiencing elevated costs due to labor shortages, supply chain disruptions, and inflation in inputs (edible oil prices have more than doubled), transportation, and packaging. In the first quarter, its gross and operating margins fell 920 and 950 basis points, respectively, to 15.4% and 6.1%. The firm is responding with price increases, freight surcharges, additional cost savings, SKU rationalization, product reformulation, signing/retention bonuses, and revised scheduling practices that allow employees to have input into their hours in an effort to reduce absenteeism. We plan to lower our fiscal 2022 and 2023 gross margins by about 500 and 300 basis points, respectively, which should result in a 3% cut to our $58 fair value estimate. With the stock down 7% on the report, shares continue to appear fairly valued and we suggest investors await a more compelling risk/reward to build positions.

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Company Profile

Business Description

Lamb Weston is the world's second- largest producer of branded and private-label frozen potato products, such as French fries, sweet potato fries, tots, diced potatoes, mashed potatoes, hash browns, and chips. The company also has a small appetizer business that produces onion rings, mozzarella sticks, and cheese curds. While 80% of revenue are U.S.-based, the firm also sells its products in Europe, Canada, Japan, China, Korea, Mexico, and several other countries. About 86% of the firm's products are distributed into the food-service channel, while the remaining 14% is sold through retail. Lamb Weston became an independent company in 2016 when it was spun off from Conagra.

599 S. Rivershore Lane
Eagle, ID, 83616
T +1 208 938-1047
Sector Consumer Defensive
Industry Packaged Foods
Most Recent Earnings Aug 31, 2021
Fiscal Year End May 31, 2022
Stock Type Slow Growth
Employees 7,800