Cadbury: A Deliciously Undervalued Stock

London-based Cadbury Schweppes (CSG) may not be as familiar to American investors as it is to those on the other side of the Atlantic. However, that lack of recognition can often work to the advantage of value hunters.

Perhaps the best way to describe Cadbury is this: take the candy operations of a firm such as Hershey (NYSE), add the chewing gum of a company like Wrigley (WWY), and then throw in the beverage distribution of PepsiCo (PEP).

With a growing assortment of mints, chocolates, jellybeans, and many other sugary treats [including the popular Cadbury Creme Egg], CSG is the world's largest confectioner. And following a key acquisition in 2003, the firm has jumped to the No. 2 spot in gum production, stocking retailers' shelves with brands such as Trident, Dentyne, and Bubblicious. Finally, a stable of thirst-quenching favorites like Dr Pepper, Canada Dry, 7 Up, A&W, Snapple, and Hawaiian Punch have made Cadbury the world's third-largest soft-drink maker.

Combined, those operations raked in nearly $12 billion in sales last year -- more than double Hershey's $5 billion.

Though revenue growth in the mature candy and beverage businesses can be somewhat elusive, Cadbury has expanded the old-fashioned way -- via acquisitions. In fact, the company has scooped up nearly two dozen firms over the past six years.

The process of integrating all those smaller pieces into a cohesive whole can be disruptive. Fortunately, Cadbury's restructuring efforts are nearing completion, and the company is now ready to put those purchases to work. With that in mind, management has recently outlined two overriding goals -- higher dividend payments and stronger returns on invested capital [ROIC].

To supplement is acquisition strategy, the firm has also found ways to stimulate its organic growth. To begin, management continues to roll out innovative new products [like Cherry Vanilla Dr Pepper] that add a new twist to an old favorite. Furthermore, the company is actively pushing into faster-growing overseas markets. Finally, given the fragmented nature of the global candy business, CSG has ample opportunity to capture market share. On that front, the firm continues to gain traction, picking up share in more than three-fourths of its top 20 markets last year.

Gum, candy, and chocolate are all staple consumer products, and only one company on the planet is a major player in all three categories -- Cadbury Schweppes.

Despite its well-known brands, economies of scale, and commanding market share lead, CSG trades at a discount to many of its peers. The shares are currently trading at just 11 times annual cash flows, versus an industry norm of 17 -- not to mention a wide 20% discount to our $54 fair value estimate.

CSG 1-yr chart

Comments

[Frank Li]

Notes from the Ira Sohn dinner in May on CSG. The notes were taken in real time, and may contain transcription errors:

<blockquote>
<b>Larry Robbins- Glenview Capital Management</b>

Robbins is a long investor but he was sure to highlight the contrasts between 2002 and 2007. Referred to an event driven mania and joked he wanted to bring his kids to se Mark Messier, but they had been IPO’d, LBO’d and 20% of one was sold to Morgan Stanley.

<b>Market Overview</b>

Dichotomy of capital structure- Public company’s not enough debt, Private company’s too much.
Real growth is scarce.
Equities cheap relative to bonds.
Non cyclical names best longs for the current environment.

<b>Long-CSG-Cadb... Schweppes</b>

Market leader in confections.
Chocolate, sugar, gum.
June 19th analyst meeting will address drink unit split off.
Beverage is believed to potentially be worth $8 billion
Improve the confectionary business
Cadbury could be a take over target with Kraft as a potential suitor
<blockquote>