Many investors seem to be suffering from a case of Mondelez.
Symptoms include obsession with the parlour game of predicting mergers and acquisitions, as well as an infatuation with growth in emerging markets that causes the investor to overlook solid cash flow and industry-leading dividends. The disease can cause long-term damage to the portfolio.
Mondelez International Inc., in truth, is the international snack-food business that used to carry the name of Kraft before a spinoff late last year. (Says the company: “Mondelez, pronounced mohn-dah-LEEZ, is a newly coined word that evokes the idea of ‘delicious world.’ ‘Monde’ derives from the Latin word for ‘world,’ and ‘delez’ is a fanciful expression of ‘delicious.’)
For much of 2013, investors have driven up Mondelez stock on speculation that activist food investor Nelson Peltz can shepherd a merger of Mondelez with PepsiCo.’s snack business. That, combined with the company’s international growth profile, makes Mondelez one of the more expensive stocks among the large packaged-foods companies.
And what of poor Kraft Foods Group Inc., left behind with the original name, the legacy North American business, and all the slow growth that entails? Well, it might provide a tasty opportunity.
Kraft’s cheeses and its Oscar Mayer packaged meats each generate a billion dollars in sales; it also owns iconic brands like Kool-Aid, Jell-O, Planters peanuts, Crystal Light, Maxwell House coffee, and A1 steak sauce. Even with all its overseas sales stripped out, it still posted more than $18-billion (U.S.) in revenue, and $1.8-billion in profits, in the last 12 months.
From that, it pays a dividend that yields 3.5 per cent, the highest among large packaged-food companies (actually, tied for top spot with Unilever NV).
“While substantial growth prospects are unlikely (with the bulk of its sales resulting from the mature North American region), we think income investors would be wise to consider the firm’s shares, as returning cash to shareholders through a top-tier dividend will be its prime use of the substantial cash flows it generates,” says Morningstar analyst Erin Lash.
Ms. Lash, however, has a “fair value” estimate of $53 on the shares, a couple of bucks below recent trades. She says the stock, at about 17 times her 2013 earnings estimate, “isn’t a steal.”
Yet in explaining Kraft’s recent history, Ms. Lash provides evidence that the company’s current management could very well continue to provide positive earnings surprises in the near term – and build a better business for the long haul.
Ms. Lash calls the company’s recent track record of innovation “dismal.” She says Kraft management recently detailed how 17 of the company’s 19 product launches in 2008 failed. In 2009, only three of 16 launches received more than $10-million in advertising support.
Similarly, management recently said some of its factories haven’t seen new investment since the 1950s, Ms. Lash wrote.
The good news about this bad news is that management, in highlighting these embarrassments, is making the case things are now being done differently. New efficiencies in old factories, as well as additional organizational improvements, can push profitability to higher levels. (Ms. Lash notes its operating margins currently sit around 17 per cent, versus 20 per cent at peers.)
Kraft’s advertising spending, also below peers, is also heading up, smartly. A recent 50 per cent increase in ad expenditures for mayonnaise helped sales jump 10 per cent, Ms. Lash notes.
To an extent, Kraft is still punished for not being a growth story. It handily beat earnings expectations in its most recent quarter, but its sales numbers posted a small decline, and shares fell. Part of that, says Barclays Capital analyst Andrew Lazar, is because Kraft declined to match competitors’ aggressive pricing for salad-dressing in the quarter.
While Kraft gets some credit for its “promotional discipline,” says Mr. Lazar, who has an “overweight” rating and $60 target price, “we think investors will need to see more stable market shares to remain comfortable with the margin and long term cash flow story.”
When that evidence arrives, however, Kraft may no longer trade at a discount to its peers. And its earnings may be considerably higher than today. More earnings, and a higher multiple attached to them, will equal a higher price. That, and a heaping helping of Kraft Dinner, is my prescription to cure Mondelez disease.