Earnings Disappointment for Kraft and Sara Lee

Kraft (KFT) and Sara Lee (SLE) reported Q4 2008 earnings and the market does not appear to be impressed. Both stocks are down primarily due to reduced future guidance.

Kraft sighted higher pension costs and the strengthening dollar as culprits for its reduced guidance in 2009. For Q4, net revenues grew +6.2%, but only +.4% in North America. They reported strength in convenient meals, led by their frozen pizza business but had disappointing results in foodservice, snacks and beverages. Pricing accounted for 9.8 points of margin, with volume actually down 5.2 percent. Clearly Kraft was aggressive in taking pricing and trying to protect margins, but it had the impact of hurting overall volume sales. Consumers continue to be more price sensitive than ever before.

The trade down phenomenon is clearly evident in Kraft's results. For example, where consumers can trade down from restaurant options to supermarket products (DiGiorno from Pizza Hut), grocery companies benefit. However, within grocery, consumers are trading down from branded to private label or trading down from a more expensive category to another. In Kraft's case, their Snacks division was the biggest disappointment. Consumers are buying less prepackaged snacks and instead buying cheaper alternatives, like baking mixes. General Mills (GIS) reported that their Betty Crocker baking mixes had stellar sales in December.

Sara Lee reported total net sales for the December 2008 quarter of +4.2% from continuing operations. Unfortunately, 7.9 points of that came from pricing, leaving it with a net volume loss of -3.7%. Only its North American fresh bakery division reported a volume gain of all 6 divisions. Sara Lee also continues to struggle with the currency exchange of the improving dollar. The trading down phenomenon continues to expand outside of the US and is now starting to impact international markets. For Sara Lee, the challenge remains, as it competes in many categories with strong private label presence and doesn't have strong number # 1 positioned brands to retain loyal consumers.

Watch for continued food company reports over the next few weeks for more signs of weakness. Hain Foods (HAIN) reports after the bell and should come under increased pressure as consumers are reducing their purchases of Organic and Natural items in favor of cheaper alternatives. Ralcorp (RAH) and Treehouse (THS) are leading private label firms and should benefit from this trade down trend. Campbell Soup (CPB) should benefit from the soup category's low private label sales penetration and escape this trade down trend, but also because soup is a value orientated category and should benefit from less restaurant sales and more grocery shopping traffic.

Disclosure: Short Hain