Mixed Plate Means Patience Before Buying Kraft Foods

| About: The Kraft (KHC)

Summary

Company efforts at controlling costs and expanding margins will fuel earnings growth.

KRFT has been increasing advertisement spending in an effort to support its sales volume.

Investors seeking dividend attracted to stock due to its 3.8% dividend yield.

Kraft Food Group, Inc. (KRFT), one of the dominant consumer staple companies in the North American market, remains focused on realizing its long term growth prospects. The company has lower margins as compared to its peers, and has been working to expand its margins. KRFT is targeting a high single-digit earnings growth rate, mainly through margin expansion. KRFT, with a dividend yield of 3.8%, remains among the high dividend paying stocks in the industry, which makes it an attractive investment option for dividend investors. I believe the stock is slightly overvalued as it is trading at a forward P/E of 16.5x, in comparison to its peers' average P/E of 15.25x, therefore, I recommend investors to wait for a pullback before initiating a 'buy' position in the stock.

Making Progress despite Difficult Conditions
KRFT's fourth quarter of 2013 was stronger than the three previous quarters, but overall it continues to face pressure in a highly competitive consumer industry due to weak consumer spending, product innovation and high advertisement spending by its peers. The company's advertisement spending lags behind its peers. The company has been eyeing to increase its advertisement spending, which will portend well for its sales volume in the future. In an attempt to increase sales and enhance consumer loyalty, the company has gone for a double digit increase in its advertisement spending in the recent fourth quarter. The increase in advertisement spending might put pressure on the company's operating margin in the short-term, however, I believe that going forward, the company's plan of expanding advertisement to sales expenditure to almost 5%-6% from 4% in 2013, and 3.5% in 2012, will portend well for its sales growth.

The following table shows changes in sales volume, pricing, and net sale changes for the last four quarters.

1Q 2013

2Q 2013

3Q 2013

4Q 2013

Net Pricing Change

(Y-O-Y- %)

0%

(0.3%)

(1%)

(0.8%)

Sales Volume

(Y-O-Y - %)

2.3%

(0.9%)

(3.1%)

3.9%

Net Sales Growth (Y-0-Y - %)

2%

(1%)

(4.2%)

2.3%

Click to enlarge

Source: Company's Quarterly Reports

Margin Improvement Story - In the Making...
The company has lower margins in comparison to its peers. The company has been working to expand its margins, which I believe remain a key stock price catalyst. The company has been improving its operational efficiency and lowering its costs to support margin expansion. Through cost control measures, KRFT is likely to increase its gross margin by 2.5%-4%, which will fuel its bottom line growth. The company is expecting high single digit growth rate for the long term, which will mainly be driven by cost control measures and margin expansion. The following chart shows that the company has lower gross and operating profit margin as compared to its peers.

Source: Companies Reports and Calculations

Investor-Friendly Returns
KRFT's solid dividend yield of 3.80% remains attractive for dividend investors. The company has a solid balance sheet and strong cash flows, which support its dividends. Also, the company has a low payout ratio of 45%, and it can further increase dividends by increasing its payout ratio.

As the company has been making efforts to lower costs and expand margins, cash flows of the company will further improve, and could result in dividend increases. The company has also been undertaking share repurchases, which will fuel its EPS growth. KRFT's ongoing share repurchase program of $3 billion represents 9% of its current market cap.

KRFT offers a high dividend yield as compared to its peers, as shown below.

Source: Wall Street Journal (KRFT, CAG, HSH)

Conclusion
The company's cost control and margin expansion measures are likely to fuel earnings growth in the coming years. Also, the company has been increasing advertisement spending to support its sales volume growth. Moreover, its solid dividend yield of 3.8% makes the stock an attractive investment option for dividend investors. Despite the bright future for the company, I recommend investors to wait for a pullback before initiating a 'buy' position in the stock, as the stock is currently trading at an expensive forward P/E of 16.5x, as compared to its peers' average of 15.25x, as shown below.

KRFT

ConAgra Foods (NYSE:CAG)

Kellogg (NYSE:K)

General Mills (NYSE:GIS)

Average

Forward P/E

16.5x

13.2x

15x

16.5x

15.25x

Click to enlarge

Source: Yahoo Finance

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.