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Kraft Foods Group, Inc. (NASDAQ:KRFT) reported Q2 earnings on August 1 with an EPS of $0.76 good for an earnings surprise of 15.2%. The company's performance was better than what analysts had expected due to cost savings and productivity gains. However, organic net revenue declined by 1.2% (lower volume mix was responsible for 0.9% and lower pricing 0.3%). I believe the company has limited potential to enhance its top line growth since KRFT cannot grow more than the North American food and beverage industry, and it has no exposure to emerging markets (a key growth driver for its peers). I consider KRFT a stable company with decent earnings and a healthy dividend yield in a current low yield environment.

Financial performance of 2Q'13

As discussed earlier, the company failed to improve its organic revenues. The table below shows the contribution made by each segment of the company. Only two categories, Cheese and International & Food Service (contribute around 42% to annual revenues), managed to perform well and showed decent growth in both volume mix and price. The primary reason for the disappointing performance in various categories is the higher marketing expense and high commodity costs as compared to previous quarters.

Category

Organic Revenue (Non-GAAP)

Organic Growth Driver

Volume/Mix

Price

Beverages

-3.2%

1.4%

-4.6%

Cheese

2.8%

1.2%

1.6%

Refrigerated Meals

-0.97%

-2.8%

2.1%

Grocery

-6.7%

-5.1%

-1.6%

International and Food Service

3.1%

2.3%

0.8%

KRFT

-1.2%

-0.9%

-0.3%

Source: Company Data

The company managed to beat analyst earnings estimates due to the benefits of market-based impacts to post employment earnings. Efficient management of capital expenditure enabled the company to reach $399 million in free cash flows in the first half of the year. The company is heavily investing in advertisements to revitalize its brands throughout various categories, but the main focus is on Mr. Peanut, Jello, and Salad Dressing for the next half of the year. KRFT has also updated its 2013 guidance for free cash flows to $1.2 billion, along with an EPS of $3.4.

Growth Drivers

The growth in volume mix in the food and beverage industry is difficult to come by, so the company has been focusing on other strategies. After the spin-off, productivity gains and cost savings continue to drive growth; the company will continue to grow, as its margins are lower when compared to its peers. Furthermore, product innovation could lead to a gain in market share and could strengthen KRFT's position to compete with other companies. These new initiatives could eventually help drive top line growth, as the product pruning hit hampered revenue growth by almost 1%.

The table below highlights the growth in the margins after the spin-off:

Margins

4Q'12

1Q'13

2Q'13

Gross Margin

25.9%

33.5%

34.4%

Operating Margin

5.8%

17.8%

6.8%

Valuation

Average P/E of KRFT

KRFT- Estimated 2014 EPS

Price Target
(Average P/E *estimated 2014 EPS)

16.8x

Bull case=3.35

$56.28

16.8x

Bearish case=2.95

$49.56

Source: Yahoo Finance

If we average out both cases, price comes out to be $52.92, which means that KRFT is slightly overvalued and is trading at a premium.

Conclusion

Companies

Dividend Yield

Growth Rate-Next 5 years

PEG Ratio

ConAgra Foods, Inc. (NYSE:CAG)

2.90%

10.58%

1.37x

Unilever NV (NYSE:UN)

3.60%

3.20%

5.61x

Kellogg Company (NYSE:K)

2.90%

7.40%

2.30x

KRFT

3.80%

6.47%

2.86x

Source: Yahoo Finance

I believe KRFT offers a decent growth opportunity with margin expansion, product innovation and cost reduction. Moreover, the company offers a striking dividend yield of 3.8%, which makes it an excellent investment opportunity for income-seeking investors. Its PEG of 2.86 is slightly higher than that of its peers, which means they offer cheaper growth as compared to KRFT.

Source: Stability Key For Kraft Going Forward