Kraft Foods: Time To Get Going

Aug.18.14 | About: The Kraft (KHC)

Summary

Company remains committed to improving top-line numbers through innovation and renovation.

Has done right by increasing prices of product in response to commodity inflation.

Offers sustainable dividend yield of 3.5%, making it attractive for dividend investors.

I reiterate my bullish stance on Kraft Foods Group (KRFT). The company's financial performance for 2Q14 remained mixed; in 2Q14, manufacturing cost and commodity cost inflation adversely affected the company's margins. However, KRFT's constant efforts to grow its top-line through price increases, innovations and renovations will portend well in the coming quarters. Also, the company's cost saving efforts to reduce its overheads stay well on track. Moreover, with its strong cash flow base, the company has been sharing its success with shareholders by returning cash through dividends and share repurchases. KRFT offers a 3.5% dividend yield, which makes it a good investment for dividend investors.

Financial Performance and Stock Price Catalysts
As of late, intense competition in the Consumer Industry has been pressurizing the top-line growths of companies in the industry. KRFT's top-line growth has also been adversely affected by the prevailing industry conditions. To address the challenges and improve its performance, the company has been making consistent efforts to innovate and renovate its diverse product portfolio, which seems to be on track. KRFT reported a modest net sales growth of 0.7%, as compared to Kellogg's (NYSE:K) net sales drop of 0.8% year-on-year in 2Q14. The following graph shows KRFT's net sales growth in the recent quarter.
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Source: Company's Quarterly Earnings Report

The timing of the Easter season and price increases positively affected the company's net sales in 2Q14. In an attempt to address the pressure of the inflated cost of coffee, meat, dairy and many other raw materials, KRFT increased prices of almost half of its product portfolio. The price of KRFT's cheese portfolio increased approximately 5%-10%, and the company also raised the price of its coffee brands by 10%.

The company raised prices for its products in response to commodity cost increases; however, the benefits of the price increases are yet to be realized in the coming quarters. The rise in commodity costs adversely affected the company's margins; KRFT's gross margin dropped from 33.60% in 2Q13 to 32% in 2Q14. The company's operating profit margin also dropped by 0.1% year-over-year in 2Q14. I believe the price increases will positively affect the company's margins in the near future.

Also, as the company has been facing challenges to grow its top-line numbers, in the current industry conditions, it has been aggressively working to lower its costs and expand margins. The company has been targeting to reduce costs by improving its manufacturing facilities and supply chain in North America. The company has a gross productivity improvement target of 5%, which is expected to be achieved by 2016. Other than 2Q14, in which KRFT's gross and operating margins were adversely affected by the rise in commodity costs, the company has done well to improve its gross and operating margins in the previous three quarters, as shown in the table below.

3Q13

4Q13

1Q14

2Q14

Gross Margin

31.5%

32.4%

34.6%

32%

Operating Margin

15.8%

15.9%

19.6%

18.4%

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Source: Company Reports

Also, KRFT has been successful in lowering its SG&A expenses in the recent past through its productivity improvement initiatives. The company has lowered its SG&A as a percentage of sales from 15.6% in 2Q13 to 13.5% in 2Q14. The following table shows the decreasing trend for SG&A as a percentage of sales for KRFT.

2Q13

3Q13

4Q13

1Q14

2Q14

SG&A as % of sales

15.6%

15.1%

17.4%

15.6%

13.5%

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Source: Company Reports

The company still has an opportunity to lower its expenses and improve its margins. KRFT currently has lower gross and operating profit margins of 32% and 18.4%, as compared to K's gross and operating profit margins of 44% and 22.3%, respectively. Going forward, as the company remains committed to improving its productivity, its margins will improve.

Value Creation

The company's free cash flow productivity remains healthy. KRFT's ability to generate strong cash has allowed the company to share its success with shareholders through dividends and share repurchases. The company offers a high dividend yield of 3.5% and has been consistently increasing its dividends. Dividends offered by the company are backed by its solid free cash flow yield of 7%. Due to its attractive dividend yield of 3.5%, KRFT remains a good investment option for dividend investors. The company also has a higher dividend yield as compared to its competitors, as shown in the table below.

KRFT

K

General Mills (NYSE:GIS)

Mondelez (NASDAQ:MDLZ)

Dividend Yield

3.5%

2.7%

3%

1.5%

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Source: Yahoo finance.com

I believe the company could also sell some of its brands, which are facing challenges to grow and remain a drag on the company's consolidated performance. KRFT can create value for investors by selling some struggling brands and returning cash to shareholders. KRFT's Jell-O and Capri Sun are two potential brands that the company could sell to create value for shareholders.

Risks

As the company operates in a mature industry, productivity improvement initiatives remain important for margin improvement and bottom-line growth. If the company fails to deliver consistent and sustainable cost cuts, it could slow the company's bottom-line growth. Also, continuous commodity cost inflation could adversely affect the company's margins.

Conclusion
I believe KRFT will deliver a healthy financial performance in the future despite the ongoing challenges faced by the company. The company remains committed to improving its top-line numbers through innovation and renovation. The company has taken the right measure by increasing prices of its product in response to commodity inflation. Also, the company has been making efforts and seems to be on track to lowering its overhead costs, which will positively affect its margins. Moreover, the company offers a sustainable dividend yield of 3.5%, which makes it a good investment for dividend investors. Also, analysts are anticipating a healthy next five years growth rate of 7.96% for KRFT. Due to the aforementioned factors, I am bullish on KRFT.

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.