Investors in Mondelez (MDLZ) were not very happy with the company's second quarter update. Shares lost a bit of ground in recent days, erasing the year do date gains after the company cut its organic full year sales growth rate.
Given the slower pace of growth, the still reasonable high leverage even after the coffee spin-off, and further struggles amidst restructuring efforts, I do not necessarily believe that current levels allow for a great opportunity.
Second Quarter Highlights
Mondelez posted second quarter sales of $8.44 billion, a 1.8% drop compared to last year. Sales fell short compared to consensus estimates as analysts were anticipating a very modest growth in sales towards $8.68 billion.
Despite the modest fall in topline sales, earnings rose by 3.5% to $622 million. On a diluted per share basis, earnings were up by 9.1% to $0.36 per share. This is thanks to sizable share repurchases which reduced the float of the company by 5% to 1.71 billion shares.
Adjusted earnings came in at $0.40 per share, a penny better than anticipated by the investment community.
Looking Into The Numbers
The overall numbers have been mixed at best. While reported revenues were down, Mondelez posted a 1.2% increase in organic sales. Yet this growth was of low quality, being driven by a 3.6% increase in average pricing, offset by a 240 basis points headwinds from the volume and mix.
The high price electricity hurt volumes while consumers were also benefiting from competitors being slow in pricing in higher input costs. The company did admit that higher pricing hurt market shares in recent months, more than it anticipated at the start.
Overall higher input costs hurt gross margins which fell by 80 basis points to 36.8% of sales. Yet real achievements were made in containing operating costs which fell by 10.2% to $2.04 billion. This allowed operating earnings to improve by 120 basis points to 11.3% of sales despite gross margin compression. In terms of the heightened focus on corporate taxes these days, it should be noted that Mondelez only had an effective tax rate of 12.4% for the quarter which compared to just 4.4% as reported last year.
Yet the biggest news might not necessarily by the performance of the business currently, but rather its outlook. Organic sales growth for the year is now seen at 2.0-2.5%, below the 3% target as released in May, and the 4% growth target as released in February.
Sales in the general inflationary continent of Latin America rose by 11.8% as reported to $1.24 billion. Results were driven by an 18.7% jump in pricing, which consequently hurt volumes by some 6.9%.
Eastern Europe, the Middle-East and Africa saw sales improve by 6.3% to $1.01 billion thanks to a 3% improvement in pricing, as well as a 3.3% benefit from higher volumes and the product mix. Notable strength was seen in Turkey and the Middle-East in particular.
North America posted a 2.7% increase in sales to $1.72 billion, driven by a 1.1% improvement in pricing and the remainder in volume and mix thanks to market share gains in biscuits and candy.
The European business suffered from both lower pricing and volumes which hurt sales as they fell by 1.9% to $3.38 billion. Lower coffee revenues as well as pricing-related customer disruptions in France hit sales.
The worst performance was seen in the Asia-Pacific region in which sales fell by 8.3% to $1.08 billion as a 1.6% increase in pricing hurt volumes and mix by 9.9%.
At the end of the quarter, Mondelez had access to $2.1 billion in cash and equivalents. Total debt stood at $18.5 billion, resulting in a rather steep net debt position of about $16.4 billion. The debt load corresponds to nearly 5 years of net earnings.
With 1.71 billion shares outstanding, and shares trading at about $35 per share, equity in Mondelez is valued at about $60 billion.
On a trailing basis, revenues came in at $35 billion, while the company reported earnings of about $3.5 billion. This values equity in the business at 1.7 times sales and roughly 17 times trailing earnings.
A Look At The Recent History
Over the past decade, Mondelez has seen a lot of developments. Of course it has long been part of Kraft Foods (KRFT) which has spun off the business in 2011. The now independent snack food company has been called Mondelez. As such direct comparisons of total revenue growth have become highly complicated following the 2009 acquisition of Cadbury for nearly $20 billion and the spin-off of course.
In a recent investor presenation, Mondelez outlined its current strategy and attempts to make further gains in the future. The company owns of course many prominent snack brands including Milka, Cote D'or, Tuc, Cadbury, Oreo, Toblerone, LU and Philadelphia among many others.
Despite the brand strength, both revenues and operating earnings have been rather flat in recent years. yet better days are anticipated with the company aiming for at or above revenue growth in the relevant categories. Operating earnings growth is targeted in the high single digits amidst further marine expansion while returns of capital should allow for double digit EPS growth.
Of course the key recent development was the creation of a key coffee player after merging with D.E. Master Blenders. The company will continue to hold a 49% stake in the business, which will be majority owned by D.E. Master Blenders. On top of that Mondelez will also receive $5 billion in cash, which is very much welcomed to reduce the leverage ratio. Following the deal, Mondelez will lose about 10% of its revenues assuming it will treat the stake as an equity investment.
Investors so far have liked the move to prepare a full spin-off of the coffee business which should result in higher and more stable margins. The company is furthermore cutting more costs in order to boost margins. A new $3.5 billion restructuring program could save the company another $1.5 billion in cash per annum by 2018, resulting in adjusted operating earnings of 15-16% by 2016.
Applying these kinds of margins on sales in the low thirty billions could result in operating earnings of close to $5 billion going forwards a few years down the road. Applying interest rate of about 5% on the net debt load of around $10 billion following the coffee deal, and applying statutory tax rates of about 35%, could result in earnings of close to $3 billion per annum.
Further earnings accretion could be seen in the year's following as further cost savings kick in. Note that the company has been paying substantially less than statutory tax rates in recent times. If it manages to keep taxes structurally lower earnings attributable to investors could approach $4 billion, implying a current valuation at about 15 times earnings.
While this appears attractive, Mondelez still has to deliver as leverage remains high and current effective tax rates appear to be unsustainably low. I remain cautious amidst this trajectory, not believing that the current risk-reward opportunity is very compelling given the challenges and work ahead.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.