Kraft Foods: Should You Drink the Kool-Aid?

After divorcing from its global snack business less than a year ago, Kraft Foods Group (NYSE:KRFT) has sought to streamline its business operations as a domestic consumer packaged foods supplier. The stock has surged around 30 percent since the spinoff, as Kraft’s management and investors alike are optimistic about higher margins and better product innovation. Can Kraft continue to grow without its snack business? Let’s use our CHEAT SHEET investing framework to decide whether Kraft is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Growth

The food giant, formerly known as Kraft Foods, broke into two separate components last October—its global snack business becoming Mondelez International (NASDAQ:MDLZ) and its North American consumer packaged food business becoming Kraft Foods Group. Kraft houses popular American brands such as Philadelphia, Oscar Meyer, Planters, and Maxwell House; Mondelez owns snack-food brands like Oreo, Chips Ahoy, and Trident gum. Existing shareholders were granted one new share of Mondelez International and a third of a share of Kraft Foods Group per one share of old Kraft. The spinoff originally occurred because the global snack business was growing much faster than the domestic grocery business. However, the newly issued Kraft Foods Group stock has actually grown more than Mondelez International’s stock on a percentage basis, since the split.

Kraft reported better than expected first quarter earnings in May, with $4.5 billion in revenues—up 2.1 percent from the previous year’s quarter. While EPS decreased 5.6 percent year-over-year, earnings still beat analysts’ expectations by 12 cents. Additionally, earnings were $0.12 lower because of a one-time restructuring charge due to last year’s spinoff. Kraft’s management has so far delivered on its promise of higher margins—gross margins were up 3.7 percent and operating margins were up 9.2 percent. Maintaining these margins though streamlining business operations and supply chain optimizations is paramount as Kraft faces increasingly difficult competition from private label brands. Kraft reports its second quarter earnings on August 1.

As part of its restructuring initiative, Kraft recently announced that it would split its grocery division in two: “meals and desserts” and “enhancers and snack nuts.” Clearly, this isn’t the type of catalyst that is going to send buyers running to their brokers, but it does speak to Kraft’s commitment in continuing to build its most popular brands. Kraft plans on ramping up its marketing budget $100 million throughout the year to protect the increasing competition its foods face from cheaper private label offerings.

E = Exceptional Performance Relative to Peers?

Kraft stacks up well against its chief competitors: Hershey (NYSE:HSY), ConAgra Foods (NYSE:CAG), and General Mills (NYSE:GIS). The company trades at a trailing price to earnings multiple of around 21.25, slightly higher than the industry average of 20.6. However, Kraft has a relatively high operating margin of 16.24 percent. If management can implement its restructuring programs effectively, Kraft’s operating margin should rise higher. While company promises are always dubious, Kraft’s margins should continue to benefit from lower input prices—namely, commodity prices—in the medium-term. Finally, Kraft has a best-in-class dividend, yielding 3.50 percent. The dividend will pay shareholders an annualized $2.00, or $0.50 a quarter.

KRFT HSY CAG GIS
Trailing P/E 21.25 29.96 19.90 18.37
Operating Margin 16.24% 18.53% 9.20% 16.25%
Dividend Yield 3.50% 1.80% 2.70% 3.00%

*Data sourced from Yahoo! Finance

T = Technicals on the Stock Chart are Strong

Kraft is currently trading at around $57.18, above both its 200-day moving average of $51.32 and its 50-day moving average of $55.25. The stock has experienced a strong uptrend since the spinoff—up around 30 percent since October 1. Kraft recently set a new high of $57.84 on Tuesday.

Conclusion

Kraft Foods Group has set earnings per share guidance of $2.75 for the 2013 fiscal year. While slightly below analysts’ expectations, this guidance puts Kraft’s growth in line with the rest of the consumer packaged food industry at 6 percent for the coming year. Kraft’s ability to sustain new product interest past the first year has often been called into question; however, management is bucking this trend with line extensions like MiO water enhancers, which grew 67 percent in the second year of its release. Additionally, Kraft differentiates itself from private label brands by its ability to create brand extensions for its already popular products—one such product planned for 2013 is Philadelphia Spicy Jalapeño Cream Cheese.

With an attractive dividend, yielding 3.5 percent, improving operating margins, and a refocused effort on brand-building, Kraft looks poised to continue its dominance in the grocery aisles across North America. Kraft faces increasing competition from lower-cost private label brands, but its impressive and growing product portfolio and its vast economies of scale should keep its market share in tact. Kraft is an OUTPERFORM.

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