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.