Kraft Foods: Safe Stock with Upside Potential
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Recently, Kraft Foods Inc (NASDAQ: KRFT) reported better than expected Q2 results with its EPS of $0.68 beating the consensus estimates by $0.02. The company’s results were helped by significant North American margins upside, solid internal growth in Europe and developing markets and hedges, which more than offset FX headwinds, an accounting time change and weakness in the gum segment. The company has been consistently posting better than expected earnings results. The following graph demonstrates KFT’s EPS performance with respect to the consensus estimates for the last five quarters.
Kraft reiterated its 2012 guidance of at least 9% EPS growth. Since the earnings announcement, the stock has seen a healthy 5% appreciation. We still see room for appreciation as Kraft continues to successfully navigate the challenging environment, given growth drivers like synergies from the Cadbury acquisition, leverage from higher margin power brands and internal growth in Europe and developing markets. The spin-off of its grocery business in North America from the snacks business in October may also prove to be a potential catalyst for stock appreciation as the break up provides investors a freedom to choose between dividend paying grocery business and a faster growing global snack business.
Cost and revenue synergies from the Cadbury acquisition
Kraft International, especially in developing markets, should continue to realize solid growth as it leverages the Cadbury acquisition and benefits from continued Cadbury cost synergies. The company is likely to realize $300 million of revenue synergies in 2012 by distributing Kraft’s biscuit products in Cadbury outlets in Mexico (approximately 380,000 outlets), distributing Oreo and Tang products in Cadbury outlets (approximately 380,000 outlets) in India and doubling its distribution in Brazil with this acquisition (from 300,000 to 600,000 outlets).
Leveraging Higher Margin Power Brands across all geographies
Kraft continues to drive growth in both North America and Global Snacks with its higher margin Power Brands. Power Brands posted 6% improvement in North America, 13% improvement in Developing markets and a significant 7% improvement in the struggling European market. As a result, Power Brand sales improved 8% in the first half and we expect the momentum to continue as the improvement was balanced with gains across each region.
Solid internal growth in Kraft Europe and Kraft Developing Markets
Kraft, like its peers, is facing challenges with weakness in Southern Europe. However, in contrast to many of its peers, Kraft continues to deliver solid performance in Europe as 1H12 internal sales improved 4%, reflecting a balanced mix between price and volume. Kraft Developing Markets achieved 10% internal sales growth in 1H12 and 8% internal sales growth during 2Q including broad based 1H sales growth across the regions. Thus, the company is successful in tapping the developing markets and we are encouraged about the future growth prospects in these fast growth regions.
Operating margin expansion across each region
The company has been generating solid operating margin expansion through price/mix as well as productivity and cost savings initiatives. Kraft North America posted an improvement of 140 bps in operating margin despite raw material inflation and 2% lower volume/mix. Kraft Europe operating margins expanded 30 bps despite higher input costs and a high-single-digit increase in A&C Investments. Kraft Developing Markets margins increased 40 basis points despite strong investments in A&C and increased overhead costs. Thus, the company continues to productively steer through the volatile commodity environment with solid operating margin expansion across all geographies.
While its peers are struggling with rising input prices, Kraft has posted good earnings despite revenue downfall. The company has been very efficient in managing input costs when compared to Kellogg’s (NYSE: K). Kellogg’s revenues increased 2.6%, but it was unable to translate the same to its bottom line and saw earnings downfall of 10.6% in the recent quarter. This clearly demonstrates Kraft’s resilience to the volatile commodity environment and better execution than its peers. Going forward, we remain confident about company’s standing and expect good results with leverages from Cadbury and higher margin power brands. Kraft has been around for nearly 250 years and even during downturns food products (being necessities) are stable. Thus, the company will remain relatively stable even in a slowdown and is a safe bet.
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The article was co authored by Sandeep Gupta and Ashish Sharma. Both have no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.
