Can Kraft Foods Meet Its Required Business Performance in a Weak Economy?

Kraft Foods has held up nicely during the crisis. It sports a hefty dividend yield and is now a Dow component. It is possible, though obviously not certain, that these factors are keeping the price of the stock too high. At its current price, Kraft Foods’ (KFT) Required Business Performance implies that sales will grow at a rate of somewhere between 2.5%-3% for the foreseeable future. This translates in to $24.5 billion in North American sales and $18 billion in international sales in the coming twelve months. Can it be done?

One of the strengths of the company, and surely a reason why Berkshire Hathaway (BRK.A) was drawn to acquire and 9% stake in the company, is the durability of the brands under which Kraft products are sold. But as economic times get tougher, these brands will provide less value to the company than they have historically as consumers become more focused on price. Said differently, while not a luxury good producer, Kraft is still susceptible erosion of market share by cheaper substitutes in an economy where consumers are assumed to be trading down to lower priced goods. “Why buy the Philadelphia Cream Cheese when I can buy Sam’s Choice for 25 cents cheaper?” might be the mentality of many consumers in a recession.

To understand the impact that such an attitude might have the company as a whole it useful to consider the components of the company’s Required Business Performance. North American Grocery revenue was $3.41 billion for the twelve months ended Mar 2009. It will need to grow to just about $3.5 billion to support the current stock price. We can expect grocery products like Philadelphia Cream Cheese and Velteeta to be more vulnerable to generic substitution than snacks such as Oreo’s, Ritz and Chips Ahoy.

Also important to consider is that these Required Business Performance numbers refer to organic growth. The snacks division saw enormous growth in 2008 due to the acquisition of Groupe Danone’s biscuit business. But the snacks division will need to itself produce 2.4% organic growth (that is, before the Groupe Danone products) and this translates to $5.1 billion in annual North American revenue. To the extent this offsets declines in the grocery business the company may be able to avoid sales declines.

So can Kraft meet its Required Business Performance and deliver sales growth of 3% annually over the next three to five years? Sales are generally fairly lumpy in this business, so it is hard to say for certain. But there is reason to believe the company might fail to deliver its Required Business Performance. For one thing, by extrapolating historical trends it seems possible but not highly likely – sales growth was (2.5%), 8.7%, 16.8%, and 0% for the twelve month periods ended 3/06, 3/07, 3/08 and 3/09. Of course these are historical numbers over a predominately strong economy. In today’s economy, for the reasons I mention above, it seems even less probable.

The company’s RBP Probability, which is calculated by relating past performance to the company’s Required Business Performance in the future, would indicate the company probably will not produce results sufficient to support the current stock price. (See KFT’s RBP Snapshot) So despite the long-term durability of the business and brands, at least in the near term it seems unlikely Kraft Foods will outperform.