Kraft Foods: Is The Rebound On?

Aug.11.14 | About: The Kraft (KHC)

Summary

Kraft Foods Q2 earnings declined 42% to $482 million or $0.80 per share compared to $829 million or $1.38 per share reported the same period last year.

Fundamentally speaking, Kraft Foods is doing better than its industry rivals.

The company’s high dividend yield of about 3.9% is likely to be a key source of investor optimism towards the stock.

Kraft Foods (KRFT), the Northfield, Illinois-based consumer packaged foods and beverages producer has been on a pullback over the last two weeks after posting dismal Q2 results that missed analyst estimates.

Before the company's announcement of Q2 results, Kraft Foods had been on an upward trend rising from $51 per share to about $60 between February and July. Over the last few days, the stock has picked up what seems to be some sort of a recovery signaling a rebound.

Why Kraft Foods Plunged

Kraft Foods missed analyst estimates following a difficult period, which saw dairy/meat costs surge by as much as 10%. In response to this, Kraft Foods raised the prices for some of its products including dairy products by 5% to 12% during the quarter.

Kraft Foods Q2 earnings declined 42% to $482 million or $0.80 per share compared to $829 million or $1.38 per share reported the same period last year. Analysts were expecting EPS of $0.83. The company added $30 million worth of revenue to $4.72 billion but still, missed analyst estimates of $4.88 million.

Nonetheless, the most significant picture in Q2 results was the fact they missed analyst estimates for the second consecutive quarter. Failing to equal or beat analyst estimates for two consecutive quarters created a bearish picture among investors.

This also implies that chances that the company could miss next quarter's earnings estimate are high, and hence this could lead to analyst revising their estimates downwards.

In fact, it did not take long for leading analysts to change their opinion on Kraft Foods. Having reported Q2 on July 30, Kraft Foods received a major downgrade from Deutsche Bank (NYSE:DB) analysts, who now have a neutral rating on the stock after downgrading it from a buy rating.

The analysts also lowered their price target for Kraft Foods from $62 per share to $59, which still represents 7% upside on the current price of $55 per share.

Why Kraft Foods Could Rebound

Fundamentally speaking, Kraft Foods still looks a better company than a majority of its pears. It is also performing better than the industry average in terms of margins, earnings and valuation multiple.

Kraft Foods currently trades at a P/E ratio of 11.89x, which appears more attractive compared to rivals' ConAgra Foods (NYSE:CAG) 16.05x, The Hillshire Brands (NYSE:HSH) 34.33x and Nestle (OTCPK:NSRGY) 21.69x. The industry average is pegged at 24.19x, which makes Kraft Foods a very interesting bet.

The company's earnings per share of $4.60 are also at the very top in the industry, easily tramping ConAgra Foods' $1.92, The Hillshire Brands' $1.83 and Nestle's $3.51. Kraft Foods also appears to be doing better than the overall industry whose average EPS stands at $0.80 for the trailing twelve months.

Kraft Foods' gross and operating margins are also among the best in the industry standing at 36% and 24% respectively for the trailing twelve months. This compares to ConAgra Foods' and HSH's 21%, 10%, and 29%, 9%, respectively.

NSRGY beats Kraft Foods on gross margin with 48% but trails on operating margin, which stands at 16%. The overall industry's margins stand at 28% gross and 8% operating.

Therefore fundamentally speaking, Kraft Foods is doing better than its industry rivals are. However, investors seem to be more concerned with the outlook, which of course is one of the most important aspects of inventing.

However, as Zacks points out, the company's recent woes are a subject of what has been happening in the overall industry, as dairy and meat products costs continue to rise. "Rising commodity costs is turning out to be a major margin headwind for the food companies in 2014."

Deutsche Bank analyst Eric Katzman also has the same opinion on the overall industry according to a research note sent to investors following the downgrade. Katzman wrote in a research note to clients,

"U.S. packaged food industry conditions have been challenging from the start of this year and have arguably become more difficult of late."

This means that Kraft Foods' challenge is macro in nature and therefore would affect all companies in the industry including rivals. The fact the company has managed to stay afloat of the industry performance in both margins and earnings means that Kraft Foods could still dig itself out of the current situation and trigger another rally.

In the company's Q2 results, management noted that the cost of cheese/milk reached record highs in the first half of the year compelling Kraft to raise prices of most of its cheese products between 5% and 12%.

Consequently, this led to some loss of market share against competing products. However, the biggest benefit in this move is likely to be in the form of protecting net margins. This is likely to improve income flow to shareholders.

Another factor that indicates Kraft Foods could still rally again is that, its current price is significantly below analyst target of $59 per share, which is just slightly below the company's recent record high of about $60. Therefore, there is still some room to run for Kraft foods.

Additionally, the company's high dividend yield of about 3.9% is likely to be a key source of investor optimism towards the stock, as this offers a significant alternative to capital gains.

Conclusion

Kraft Foods has endured a tough period over the last few weeks losing close to 12% of its value. However, the company seems to be overcoming that as it is now up 2% over the last one week. This appears to be a genuine recovery campaign as much of the beating received was largely due to the negative sentiment from investors following weak results.

As discussed, the company appears to have solid fundamentals in terms of comparative performance with peers and industry. Furthermore, it is also paying a healthy dividend, which should boost investor sentiment going forward especially those with a long-term view of the company.

The bottom line is that despite the recent plunge and downgrades, Kraft Foods' target price is still above its current market price, which means there is still some upside potential in this stock, albeit small. However, the most important thing is Kraft Foods is not the only company facing the wrath of rising commodity prices and should therefore; reflect a fair valuation when compared to rivals.

Its current valuation multiple of 11.89x makes the stock appear significantly cheaper than the industry average, which means any positive news could easily boost Kraft Foods' valuation by investors.

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.