Lamb Weston Earnings: Despite Softer Restaurant Traffic, Pricing Bolsters Profitability; Shares Rich

Narrow-moat Lamb Weston LW delivered strong fiscal 2023 fourth-quarter marks, with net sales of $1.69 billion and diluted EPS of $1.22 outpacing our $1.66 billion and $0.89 preprint estimates, respectively. But management alluded to elevated potato costs in fiscal 2024 stemming from poor crops in North America and Europe, which led to 20% and 35%-40% increases in contract prices, respectively. Even despite these higher costs, management’s fiscal 2024 outlook for net sales of $6.7 billion-$6.9 billion and diluted EPS of $4.95-$5.40 exceed our $6.6 billion and $4.77 preprint respective forecasts, and we anticipate bringing our estimates closer to the guided ranges. This should lift our $74 fair value estimate by a mid-single-digit rate, but after the 7% rout in the stock price and, even with this bump, shares still trade roughly 35% north of our intrinsic valuation. We believe the market is crediting seamless execution and overestimating the long-term growth prospects of the business and, as such, we’d suggest investors remain on the sidelines.

In the quarter, organic net sales shot up 14%, driven by a 24% benefit from price/mix partially offset by a 10% volume decline, while the adjusted operating margin expanded 250 basis points to 14.3%. We attribute this performance to Lamb Weston’s efforts to raise prices surgically and prudently exit lower-margin business to combat ongoing inflationary pressure across its commodity basket (potato, edible oil, energy, and labor). And although volume fell sequentially as casual and full-service restaurant traffic decelerated each month during the quarter, we expect fry attachment rates to remain resilient (in line with historical levels), which aligns with management’s rhetoric that attachment rates stood well above prepandemic levels in the quarter. When taken together, these results fail to alter our long-term view for mid-single-digit top-line growth on average beyond fiscal 2024 and high-teens operating margins by fiscal 2032.