Kraft GroceryCo: Brands vs. Private Label
Jane is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Kraft (NASDAQ: KRFT) announced last August the split into North America groceries and global snacks. This is exactly the kind of event which brings on investments from hedge funds, licking their chops that share value will break open. Insider Monkey, which tracks hedge funds, found that at the end of 2011, 38 of them owned about a total of $6 billion of the $68 billion Kraft market capitalization. Those include funds run by Warren Buffett, Bill Ackman, Nelson Peltz, and Patrick McCormack. The stock is trading at 39.03, near its 52 week high of 39.99, with the low at 31.88. 1Q revenue was up 4% However, post-spinoff, there is significant risk with GroceryCo.
Just how will the grocery brands, touted as the crown jewels of Kraft, hold up against private label? Those range from Philadelphia Cream Cheese to Maxwell House Coffee. Unbundled from global snacks, North America GroceryCo is on its own in a slower growth economy than that of emerging nations. It's also playing in a distressed sector. A number of its traditional retail customers such as Safeway and A&P are struggling. Only recently have the less traditional such as dollar stores begun to stock more national brands along with private label. As yet, the jury is out about how national brands will sell at the bottom of the market.
It's difficult to project into the future on this one. That's because the past is no longer prologue, not in an uncertain economy. And not with retailers like Kroger (NYSE: KR) which implemented the dominance of private label as a survival strategy. Kroger even has its own facilities to manufacture private label. In Kraft’s past, observes financial writer Stephen Simpson, it had done better than competitors such as Kellogg (NYSE: K) and General Mills in protecting grocery market share from the private labels. What’s helped there is the company’s good relations with retailers. That’s a prerequisite for getting and increasing shelf space. Brandname snacks, of course, are less vulnerable. Part of that strength comes for the heavy promotions, as with the SuperBowl commercials. The global moat surrounding snacks could be one reason why Kellogg acquired Pringles. In emerging nations such as India, grazing is a dominant eating pattern. Snacks, especially brandnames which symbolize middle class status, are golden. Kraft admits that Mondelez, as it named the new snack company, will have more growth than the grocery division.
So, assessing the risk for North America GroceryCo is tricky. Whose economic forecasts does anyone really buy into? What we do know is that there is a correlation between private label growth at the expense of national brands and the GDP. In its report “Private Brands U.S. Outlook: Flash in the Pan or the Real Deal?” Nielsen documents the 21% dollar growth in private label from the onset of the recession until last 2011 when things began to pick up a bit. At the same time national brands increased by 3%. If the recovery continues there could be trading up and more total dollars spent. If there is stagnation, there could be trading down and fewer dollars spent. However, as Nielsen also indicates, given that the quality of private label is up and the stigma lessened, new buying habits have been formed. Like habits in general, they are unlikely to change easily.
Another piece to factor in is that North America includes Canada. Perhaps because that nation wasn’t hit as hard during the recession, there wasn’t the intensive flight to private label that occurred in the U.S. In addition, national brands there protected market share with discounted pricing and special deals. The better economic picture might have given the national brands the optimism to make such an investment. In its report “Canadian Private Label: The Value Alternative 2011,” Nielsen notes that private label lagged the growth of national brands, at least up to late 2011. After that, commodity prices increased, raising the prices of both national brands and private label. As a result, private label has increased to about 18.3% market share. Since commodity prices are expected to continue rising, there could be a more enthusiastic embrace by Canadians of private label.
The third piece investors have to look at is the uneven acceptance of private label. Make periodic visits to the cracker aisle in Wal-Mart (NYSE: WMT) and you will notice a growing number of its own Great Value entries, standing side by side with national brands such as Kraft’s Ritz. On the other hand, no matter how often we check out Wal-Mart’s coffee aisle the number of private label doesn’t increase. In fact, Maxwell House seems to get more shelf space than other national brands. According to Product Launch Analytics and Packaged Facts, in 2011, 30 new private label coffees were introduced versus 13 in 2006. At the same time, only about 9 cents of each coffee dollar is being spent on private label compared to 23 cents on private label in general. Some of the Kraft grocery portfolio will remain stable or grow and some is likely to shrink. Investors have to size up which brands should be sold as Kraft decied in 2007 to do with Post.
Fourth, the reality is that retailers who rely on impulse purchases, in which price counts less, are finally embracing private label. For example, walk into the 7-11 and you will find non-edibles such as paper products to be private label. This is usually the safe way to start stocking private label. Positive customer reaction could accelerate the trend. Convenience stores are now major Kraft customers.
Fifth, retailers which have been in private label for a while are becoming more strategic in their approach. Drugstore chain Walgreen (NYSE: WAG) has fused all its private labels in the umbrella “brand” Nice! This class of retailers is also leveraging the tactics of national brands. Wal-Mart uses in-aisle displays for the Sam’s Club cola, which retails at 84 cents versus about $1.28 for national brand Coca-Cola. Those used to be reserved for special promotions by national brands.
Sixth, retailers at the lowest end are introducing more national brands. Family Dollar announced this strategy, along with adding fresh produce. Ironically that could increase sales of private label since the price differences are side-by-side. This can leave the consumer with the sense of having made a smart purchase.
With the past no longer being a credible guide for assessing the future, investors have to track North America GroceryCo as the new entity that it is. What can be predicted is that it will have most of the problems and surprises of newness. Think of Groupon, post-IPO. And Facebook, after its debut as a public company, will be the most closely watched stock ever. Kraft GroceryCo demands that kind of attention.
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