A Buffett Pick That Looks Crafty, With a 'K'
Palwasha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
For exactly a decade, Kraft Foods (NASDAQ: KRFT) has traded within the $22-$39 range. It crossed the $40 mark last month to reach its 52 week high of $42.44. This was due, in part, to positive earnings announcement earlier the same month and also the nearing spin-off date. Another positive news item has been the likely increase in dividends to $2/share in the coming year, up from current $1.16 which the company has maintained for the last three years.
Amid good news, there has been some bad news as well. One, Berkshire Hathaway (NYSE: BRK-A) trimmed down its stake in the company by over 32% (from December last year to this year's latest filing), selling off 28 million shares. But we don't know for sure whether this was Buffett's move or of others overseeing the fund. Nonetheless, that was a huge dump. Two, Kraft's CEO warns that if the US government cuts down on SNAP subsidies for food stamps, Kraft may get into some trouble as food stamps account for 1/6th of its total revenues. Three, Kraft's management has warned that Kraft's soon-to-be-spun-off subsidiary, Mondelez International, may get hit by unfavorable foreign exchange fluctuations. The announcement came on Thursday last week and the stock was down by 5% on Friday. One can expect that the market has priced in the bad news and the stock's jump back to $40 on Monday is proof of it.
One important post-spin-off concern
Most business students and professionals today recognize the famous 80-20 principle by Pareto. The principle, that in general terms says that 80% of all results are achieved by 20% of all causes, can be applied in various settings. IBM is amongst the first few companies to apply this principle in explaining how 80% of a computer's time is spent in executing 20% of the operating code. Back in the 90s, IBM was able to build faster machines than its competitors using this very thesis. Later, Microsoft and Apple also used it to their advantage.
A variation of this principle could be that 80% of a company's revenues are generated by 20% of its products. Kraft Foods is one company that perfectly fits this description. The packaged foods company divides its consumer sectors into confectionery, biscuits, beverages, cheese, convenient meals, and grocery. While the first three of these six sectors account for 80% of its profits, when we break down the sectors into individual brands, it's the top 12 brands (18%) out of the portfolio of its largest 66 brands that generate 80% of its profits; Oreo, Cadbury, Trident, Milka, Tang, Oscar Mayer, Maxwell House, Kraft, Jacobs, LU, Philadelphia and Nabisco.
Now, we are all aware of Kraft's final announcement of its divestiture that will be taking place in 15 days’ time. The spin-off will divide the company into Kraft Foods Group (post spin-off symbol: KRFT) and Mondelez International (post spin-off symbol: MDLZ). The spin-off will also divide the portfolio of the top 12 brands which generates the most revenues for the parent today. Kraft Foods Group will do away with Kraft, Oscar Mayer and Maxwell House and the rest will go to Mondelez. So, the spin-off comes at the price of splitting Kraft's best most certain 80% revenues and investors will have to make a choice which part of the company they want to hold next (if at all). Whether the company will be able to control its already falling margins once the spin-off is complete remains a question until the divestiture, but one thing is for sure, Kraft's management would not have gone for the divestiture had it not seen reverse-synergies in play. Revenue growth has suffered over the past year and management is not wrong in eyeing the spin-off as a source of unlocking better shareholder value with the two parts divided, opposed to one whole.
Plus, all good news, bad news and concerns aside, it's only fair that I compare Kraft with its peers for a final verdict on the company--to see whether the bad news hold any water and whether more bad news are on their way. General Mills (NYSE: GIS) and PepsiCo (NYSE: PEP) are two of the closest competitors that I've picked for comparison. Except for a positive EPS growth, I don't see any financial metric in Kraft's favor. And despite the positive EPS growth, its revenue growth is still a negative 4.27%, the worst amongst the three.
KFT Earnings Per Share Growth data by YCharts
Its dividend yield is also the lowest amongst peers.
KFT Dividend Yield data by YCharts
Kraft's long term debt is the highest amongst competitors and its free cash flows don't inspire when compared to PepsiCo.
KFT Long Term Debt data by YCharts
It is important that I mention, however, that Kraft has more cash and short term investments on hand than the other two (as if that makes any significant difference to Kraft's financial health). Kraft currently has the highest P/E of all three--19.76. However, its forward P/E of 16.21 falls between General Mills' 14.83 and PepsiCo's 17.65 (data for P/Es is taken from Nasdaq).
Bottom line
Consider buying PepsiCo or General Mills. Kraft looks crafty.
PalwashaS has no positions in the stocks mentioned above. The Motley Fool owns shares of PepsiCo. Motley Fool newsletter services recommend PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
