Krafting A Killer Dividend

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Oct. 1, Kraft Foods spun off its North American foods business. This left two companies, Mondelez International (NASDAQ: MDLZ) and the new Kraft Foods Group (NASDAQ: KRFT). While Mondelez operates in high-growth international markets, the new Kraft is comprised of a stable of mature, reliable brands such as Maxwell House, Jell-O, Cool Whip, Ritz, Velveeta, and almost countless more. The spinoff allows the new Kraft to focus on slow, reliable growth and a dedication to returning shareholder value.

A Hearty Dividend
Kraft declared a $0.50 quarterly dividend, or $2 per year, which puts the yield at a hefty 4.3%.  Other large food companies can't match Kraft on yield. General Mills (NYSE: GIS), which owns brands such as Cheerios, Pillsbury, and Yoplait, pays a 3.16% dividend. ConAgra Foods (NYSE: CAG),  known for its Banquet, Chef Boyardee, and Healthy Choice brands, pays a similar 3.3% dividend. These both pale in comparison to the new Kraft dividend.

In terms of growth, General Mills grew its dividend by nearly 9% last year and by 16.67% the year before. Meanwhile, ConAgra's dividend grew by 6.7% last year and 12.7% the year before. It's difficult to predict Kraft's growth rate going forward, but Kraft has stated that it is committed to 5%-9% dividend growth. I think it's safe to say that Kraft's dividend growth rate will be slower than its peers', but the extra yield may make up for it.

Is Kraft A Value?

Since we don't know how fast Kraft's dividend will grow, I'll do a reverse dividend discount calculation. The dividend discount model assumes that the value of a company is the sum of all future dividend payments discounted back to today. Since Kraft is aiming to become a dividend stock, this method is reasonable to use here. Instead of inputting a growth rate and outputting a stock value, I'll do the reverse. This will tell us the minimum growth rate that justifies buying Kraft at its current market price of $46.33.

For my discount rate, I like to use 8% for dividend discount calculations. This is roughly the long-term growth rate of the market as a whole. One other assumption: After 10 years, I'll set the perpetual growth rate to 3%. So we're searching for the 10-year annual growth rate here. Using this discount rate and adjusting the growth rate to get the current market price, I arrive at a minimum dividend growth rate of 4.48%.

What does this mean? Kraft only needs to grow the dividend at a 4.48% annually to justify the current share price. In other words, Kraft is a bargain.

Here's a table of the fair value of Kraft, assuming various dividend growth rates:

<table> <tbody> <tr> <td><strong>Growth Rate</strong></td> <td><strong>Fair Value</strong></td> </tr> <tr> <td>3%</td> <td> $41.20</td> </tr> <tr> <td>4%</td> <td> $44.59</td> </tr> <tr> <td>5%</td> <td> $48.27</td> </tr> <tr> <td>6%</td> <td> $52.25</td> </tr> <tr> <td>7%</td> <td> $56.55</td> </tr> <tr> <td>8%</td> <td>$61.20</td> </tr> <tr> <td>9%</td> <td>$66.23</td> </tr> </tbody> </table>

If the range given by Kraft is correct (5%-9%), then a share of Kraft is worth somewhere between $48.27 - $66.23 today.

The Bottom Line

The new Kraft looks like a fantastic dividend stock at the current market price. At a current yield of 4.3%, Kraft only needs to raise it's dividend by 4.48% annually to be fairly valued. Since it seems likely that the true dividend growth rate will be faster than this, Kraft offers a great opportunity to pick up a high-yielding stock with the potential to grow the dividend in the high single-digits. No other food products company offers a yield this high, and while Kraft's growth may lag its peers, the full picture looks promising. If you're a dividend-focused investor, Kraft should be part of your portfolio.

TheBargainBin has 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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