Can Kraft Preserve its Flavor?

By Ryan Guenette - August 1, 2012 | Tickers: CAG, GIS, K, KRFT, UN | 0 Comments

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The year is 1765. John Baker, a Harvard-educated doctor, has just associated himself with John Hannon, a young Irish immigrant, who doubles as a chocolatier. The gentlemen begin their business expansion plans by importing cocoa beans, which yield rich and creamy chocolate through a process implemented in a minuscule, wood-framed mill along the banks of the Neponset River, just outside of Boston. When the British enforced a tea tax upon the colonists in 1773, the company exploded in sales, as angry and irritated colonists turned to hot chocolate as an alternative to tea. Seven year later, in 1980, Baker’s Chocolate sold its first official product.

Now, 250 years after the establishment of Baker’s Chocolate, Kraft Foods Incorporated (NASDAQ: KRFT) is the second largest food company in the world, with annual revenues of more than $54 billion. Since Kraft went public on June 22nd, 2001, its shares have risen 28.81%, and it has paid out consistent dividends during this period. Kraft has made its meteoritic rise from a meager producer of chocolate to a global leader in biscuits, chocolate, gum, candy, and nuts; but can it preserve its flavor?

Appetizing Growth

In 2010, Kraft reported earnings per share of $2.39. In 2011, Kraft Foods Incorporated stated that earnings per share had fallen $0.40, to $1.99, representing -16.74% year over year earnings per share growth. In 2012, the average consensus sees Kraft’s earnings per share stabilizing at $2.26, displaying 13.58% year over year earnings per share growth. In 2013, the Street anticipates acceleration in earnings per share growth, as Kraft’s earnings per share grow to $2.76, presenting 22.12% year over year earnings per share growth. The trend of double digit growth is projected to continue into 2014, with earnings per share rising 12.68% to $3.11. Kraft’s earnings per share growth is slightly unstable at the beginning of this timeline but steadies into double digit growth by the end of the spectrum. Kraft’s growth is largely expected to be drawn from its emerging market exposure; with the growing middle class in emerging markets such as India, China, and Brazil, there is a greater demand for necessities, such as food, and luxury products, such as candy. The chart below displays the rise in the percentage of the world that classifies as being part of the middle class, Kraft’s target market.



Kraft’s growth in earnings per share is not mouth-watering, but it does look attractive long term. The chart below displays Kraft’s sales, operating profit, net income, net margin, operating margin, earnings per share, dividend, and rate of dividend (the percentage of net income that is paid out in the dividend) over the foreseeable future.   

Unlocking Value will Make for a Scrumptious Treat

In early August 2011, Kraft announced that it would be dividing into two separate companies. One of the companies Kraft will split into is a grocery business, which includes brands such as Kraft Cheese, Maxwell House Coffee, and Oscar Mayer. The grocery business side of the split is expected to be a company that pays a healthy dividend and that can stably grow free cash flow. This business is expected to be the slower grower of the two, and will inherit the $10 billion in debt and $4.4 billion in pension liabilities. The other side of this split is the global snacks business, which includes brands such as Oreo and Nabisco. The global snacks business side of the split is anticipated to be a company that could become a more dominant growth machine. By announcing the split, management catered to a long-standing call to unlock investor value. By breaking up the massive company, management is allowing investors to decide if they are more interested in a dividend paying grocery business, or a more nimble and faster growing global snack business.

Is Kraft the Cookie with the Most Chocolate Chips?

Compared to some of its largest competitors, such as General Mills Incorporated (NYSE: GIS), Kellogg Company (NYSE: K), Unilever N.V. (NYSE: UN), and ConAgra Foods Incorporated (NYSE: CAG), Kraft stacks up about in-line.

Kraft is the second fastest growing company in the industry, with Unilever taking the top position in the industry. In terms of dividend yield, Kraft is the worst in the industry, being the only company without a yield above 3.00%. Kraft is also the worst company in the industry in terms of dividend growth, which will ensure Kraft’s position as the lowest yielder in the industry in coming years. In the area of fundamental ratios, Kraft does not disappoint, but does not excel either. With regards to its price to earnings ratio, Kraft is relatively average, while the biggest bargain appears to be Kellogg’s. In the PEG ratio comparison, Kraft again remains average, while ConAgra looks like the biggest bargain when growth is taken into account. In the net profit margin comparison, Kraft and ConAgra are the only two companies without a net profit margin above 9.00%.

The Foolish Bottom Line

Kraft has underperformed the S&P 500 since its initial public offering in 2001, but has recently released plans to split its core businesses into two, releasing significant investor value in the process. Kraft is not in a fast-growing industry but has enough growth to support a decent dividend. Compared to its peers, the company appears to be middle of the road, as more attractive plays on this industry appear in the form of Unilever and General Mills, but it may begin to outperform the market as emerging economies present opportunities. In this volatile economic environment, nothing is more stable than necessities, such as food products, and Kraft has been around for nearly 250 years. Kraft may not be the cream of the crop, but it will be around for a long time to come.         

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