Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

David Brearton - Chief Financial Officer and Executive Vice President of Operations

Irene Rosenfeld - Chairman and Chief Executive Officer

Christopher Jakubik -

Analysts

Diane Geissler - Credit Agricole Securities (USA) Inc.

Alexia Howard - Sanford C. Bernstein & Co., Inc.

Andrew Lazar - Barclays Capital

Jonathan Feeney - Janney Montgomery Scott LLC

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Scott Mushkin - Jefferies & Company, Inc.

Eric Katzman - Deutsche Bank AG

Edward Aaron - RBC Capital Markets, LLC

Bryan Spillane - BofA Merrill Lynch

David Driscoll - Citigroup Inc

David Palmer - UBS Investment Bank

Kraft Foods (KFT) Q2 2011 Earnings Call August 4, 2011 8:00 AM ET

Operator

Good day, and welcome to Kraft Foods Second Quarter 2011 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Kraft management and the question-and-answer session. [Operator Instructions] I'd now like to turn the call over to Mr. Chris Jakubik, Vice President, Investor Relations for Kraft. Please go ahead, sir.

Christopher Jakubik

Thank you. Good morning, and thanks for joining us particularly since this call is quite a bit earlier than you were expecting today.

With me are Irene Rosenfeld, our Chairman and CEO; and David Brearton, our Chief Financial Officer. Earlier today, we sent out 2 releases: our second quarter earnings report and an announcement of our intent to create 2 independent companies. These releases, along with today's slides, are available on our website, kraftfoodscompany.com.

Before we get started, please note that during this call, we'll make forward-looking statements about the company's performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our 10-K and 10-Q filings for more details on our forward-looking statements. Some of today's prepared remarks include non-GAAP financial measures, and you can find the GAAP to non-GAAP reconciliations within our earnings release and at the back of the slide presentation.

Let me now turn it over to Irene.

Irene Rosenfeld

Thanks, Chris, and good morning. And thanks to all of you for getting up so early for our news. As you've now seen, we made 2 very significant announcements today. First, we reported terrific second quarter earnings. Concurrently, we announced our intention to create 2 independent publicly traded companies by the end of 2012, as the next step in the transformation of Kraft Foods.

We'll begin today with a review of our quarterly results. Then, we'll spend the balance of our time on the strategic rationale and benefits of our plan. So let's get started.

In the second quarter, we delivered strong top and bottom line results, continuing our positive momentum through the first half of the year. This sets the stage for strong growth in the second half and positions us well for the next phase of our transformation.

We talked a lot in the first quarter about the challenges facing us due to higher input cost. We said we would manage them, and we have. I'm pleased to say as we exit the first half, with strong results and good momentum, that we're over the hump and we're quite confident about the balance of the year.

Here are 3 reasons why: First, an input cost increase we quickly priced to offset them. Across our categories, we've announced about 85% of the pricing that we currently expect to take. More than 80% of these increases are already reflected on store shelves. In most cases, we took action earlier than others and in certain categories, we priced quite a bit more aggressively than our key competitors. The fact that we responded quickly to these higher than anticipated costs has put us in a much more favorable position in the marketplace.

The second reason I'm confident about the balance of the year is that we're winning with our consumers. We've been able to post solid market shares, while pricing aggressively. This is due to our ongoing investments in innovations and marketing. Revenue gains for innovation are up in each region. We're continuing to improve the quality of our advertising, and we're supporting these efforts by increasing our investments in advertising and consumer marketing support, which are up strongly year-to-date.

Of course, as we raise prices, we have experienced some near-term dislocation in certain categories. But overall, we're seeing solid market share performance across our 4 categories in each of our 3 geographic regions. And it's important to note that Private Label's market share is essentially flat in our 4 categories.

What also gives me confidence in our business momentum is that despite the substantial increases in input cost, we're growing profit dollars through a combination of pricing and End-to-End Cost Management.

In fact, despite the loss of the Starbucks CPG business and tough comparisons against peak margins in the second quarter last year, we grew profit dollars year-on-year. Cost savings are enabling us to continue to fund significant increases in A&C. That in turn is fueling our virtuous growth cycle.

I'd especially like to highlight the progress we're making in our Global Snack category. Many of you have asked if the Cadbury acquisition is driving the growth we thought it would. The answer is an unqualified yes. Last fall, at our Investor Day, we laid out a long-term growth target of mid- to high-single digits for Global Snacks.

As you can see, the 6% growth we've delivered year-to-date is right in line with that target, and we've only just begun to realize revenue synergies.

Let's look at the key contributors to that growth.

Global Biscuits is up 7% on a constant currency basis, led by strong double-digit growth in developing markets.

Let's look at some numbers. Oreo, a $1.5 billion brand has grown 22%. Chips Ahoy!, a brand sold primarily in developed markets is up 18% and Club Social, our leading cracker brand in Latin America, is up 35%.

Our Global Chocolate Category is growing even faster than Biscuits. It's up about 9%, including gains of low to mid-teens in developing markets.

Our $1 billion Cadbury Dairy Milk brand, first introduced in 1905 and now sold in 30 countries around the world, has grown 13%, gives some perspective that's the best growth in many years.

Lacta, a $700 million brand in Latin America is up 18%, and Cadbury Flake, a leading brand in many hot weather markets is up 13%.

Even Gum & Candy, which has experienced significant challenges, has grown 2% year-to-date, including a high single-digit gain in developing markets.

As we've said before, the key challenge for Gum & Candy is in developed markets. Revenues are down double digits in North America and are flat in Europe. While we're certainly not satisfied with our Gum results, we expected a slow first half due to 2 factors. First, sluggishness in the instant consumption channel as a result of the challenging macro economy. Specifically the decline in pocket money among teens, our biggest consumer segment. And second, our new products this year were simply not as robust as we had hoped or as strong as last year's innovations. We understand the issues and we're in the process of fixing them with additional innovation and smaller-pack sizes to hit lower price points. We expect to see better results as the year progresses.

That said, Gum & Candy remains an attractive category with excellent long-term growth prospects consistent with our Global Snacking goals.

Let me now turn it over to Dave, who will provide more detail on our second quarter results.

David Brearton

Thanks, Irene. In a nutshell, we've seen terrific results on both the top and bottom lines through the first half of the year. We're seeing pick up from our focused investments behind our power brands, big bets on in innovation and improved marketing. As a result, we built good volume mix, share and revenue momentum in the face of aggressive price increases.

In the second quarter, organic revenues were more than 7%, including Power Brand growth of about 9%. Of course, the second quarter benefited from Easter, but looking at the first half, which normalizes for the Easter shift, organic revenue was still up nearly 6% with very solid contribution from vol/mix of 1.3 points. This was despite substantial pricing of 4.6 points.

What can we expect going forward? For the full year, we now believe input cost will be up in the low teens versus last year. That's up from the high single digit increase that we forecast on our call 3 months ago.

As a result, we do anticipate additional pricing actions to offset this higher costs, but as Irene mentioned, we've already announced or implemented about 85% of the pricing actions we expect to take for the year so we're confident in our outlook.

Turning to profits. We continue to gain momentum. Pricing and productivity gains essentially offset higher raw material costs on a $1 basis. At the same time, continued improvements in overheads and other cost savings under the strong increase in A&C.

To put it another way, we protected operating profit dollars in the quarter, even though our OI margins declined compared to peak levels a year ago. But this was essentially due to the impact of pricing under denominator of the margin calculation.

Despite this, our underlying operating income margin improved sequentially from the first quarter and for the second half, we expect to see increases in year-over-year margins.

Turning to EPS. As we outlined in our last earnings call, we expect second quarter operating EPS to be down versus the base of $0.60 last year. We knew we were up against difficult comparisons with peak margins in Q2 2010, as well as the reversal of mark-to-market gains in Q1 this year. But clearly, we did better than our initial expectations.

Mark-to-market gains did reverse and at $0.05, they were a bit more than we expected. As for the upside, partly due from favorable currency and somewhat due to a lower than anticipated tax rate, the rest came from operating gains.

On a year-to-date basis, we're encouraged that we delivered $0.06 of operating gains year-over-year despite the fact that we were up against some very difficult margin comparisons to the prior year.

All of our geographies contributed to the strong performance in the quarter. In North America, despite a very difficult operating environment, our virtuous cycle continues to build momentum. Organic revenues were up 4% for the quarter and 3.1% for the first half. As expected, pricing was the key driver. As we said, we priced to offset higher cost earlier than most of our competitors. As a result, all mix declined as we thought from near-term dislocations in certain categories.

Despite the significant pricing, however, we were pleased overall with the limited volume elasticity. It was consistent with our expectations and further evidence of the improved strength of our brand equity.

While our Power Brands grew at above the same rate as our broader portfolio, several of our innovations made significant contributions. Our new MiO liquid beverage mix continue to generate revenues well ahead of plan. Oscar Mayer Carving Board cold cuts, Newtons Fruit Thins cookies and Philadelphia Cooking Creme, also performed well.

As a result, through the first half of the year, our market shares in North America remain solid. More than half the business is holding or gaining share on a $1 basis.

And we're even more encouraged by the fact that to date, we've announced roughly 85% of the pricing we believe we need to take this year. Almost all of that pricing is already reflected on store shelves.

Now let's take a look at profitability. North America did a good job of pricing to offset higher raw material costs on a $1 basis. The region also continued to benefit from lower overheads. Nevertheless, operating income margins declined for peak levels a year ago due to changes in the U.S. Premium Coffee business and the denominator effect of higher pricing on the margin calculation. Looking ahead, we expect year-on-year margin improvement in the second half.

On the other side of the Atlantic, our European team recorded a sixth consecutive quarter of top and bottom line growth. Organic revenues grew 6.4% in the quarter, while in the first half they rose 5.4%.

As expected, pricing drove the majority of this growth, as we successfully implemented actions across all categories. As we look ahead, price increases for the third quarter have been announced in Coffee. With that, we've now announced all the pricing we expect to take in Europe this year and about 80% of our pricing is now reflected at retail.

Power Brands rose 8%, including 17% of Oreo fueled by launches in Germany and Austria, leveraging our global play book. Tassimo grew 19% while [indiscernible] Coffee increased 24%.

In addition, Philadelphia continue to grow strongly up 18%. And while retail sales are slowing across the region, we are continuing to drive growth for our brands and for our categories.

On a Pan-European basis, year-to-date, we're increasing share of biscuits and cheese and shares are holding up well in Chocolate, Gum and Coffee.

There's also good news at the profit line. Despite a difficult environment, Europe delivered another strong quarter. On a $1 basis, pricing and productivity offset the significant increase in raw material costs. While the denominator effects of pricing were a significant headwind to margin performance on a percentage basis, our continued focus on lowering overhead enabled us to post a modest increase in OI margins.

Turning to Developing Markets. We generated double-digit growth and a good balance of all mix and pricing. Organic revenues grew 13.5% for the quarter and in the first half, revenues were up 11.6%.

Power Brands rose 20% in the quarter led by 62% growth of Oreo. [indiscernible] Club Social crackers grew more than 40%. Lacta Chocolate was up 23% and Halls rose 16%.

Within this segment, Asia-Pacific and Latin America continue to grow double-digits. And CEEMA was up nearly 10% as economic conditions begin to recover in many parts of the region.

Operating income margin in the quarter rose to 14.2%, driven by overhead leverage and vol/mix gains. OI margins increased even as we continued to invest in our brands, including a strong double-digit increase in A&C.

So what does this mean for the full year? Based on our solid results through the first half, and our outlook for the balance of the year, we're raising our full year 2011 guidance. On the top line, we've increased our organic net revenue guidance to at least 5% from at least 4% previously. This is mainly due to the impact of additional pricing.

On the bottom line, we're raising our operating EPS guidance to at least $2.25 from at least $2.20 previously. Our guidance reflects process optimism for the balance of the year. Through the first half, we delivered strong operating gains and currency has been favorable. As a result, we're dropping the year-to-date currency benefits to the bottom line.

We remain cautious with the number of uncertainties in the environment, but our End-to-End Cost Management initiatives and strong revenue growth give us confidence that we will continue to deliver high quality, sustainable growth for the balance of the year.

As our performance over the past several quarters has demonstrated, our virtuous cycle is working well around the world. A key focus on Power Brands, categories and markets is driving top-tier growth in each region. We're successfully managing unprecedented input cost through renewed pricing power and improving productivity. And our End-to-End Cost Management has generated the savings necessary to expand profits and reinvest in further brand building and innovation.

As a result, Kraft Foods is now positioned to deliver reliable, top-tier growth on both the top and bottom line.

Now I'll turn the call back to Irene.

Irene Rosenfeld

Thanks, Dave. As you can see, our year-to-date results are strong. Our operating momentum continues to improve and we're confident in our outlook for the balance of the year. Clearly, our strategy is working. And it would be easy to leave it at that, but we believe there is a significant next step that we can now take that will put our business on an even higher trajectory.

Over the past 4 years, we reinvigorated our iconic brands around the world, and we've successfully transformed our portfolio. We built a Global Snacks powerhouse and we've strengthened our presence in fast-growing developing markets through several strategic acquisitions, including New Biscuits and Cadbury.

In addition, we divested certain slower growth, slower margin businesses. The combination of these actions has fundamentally changed the face and the footprint of our company.

As we look to take our performance to the next level, we recognize that there are very different opportunities to enhance shareholder value between our Global Snacks business and the balance of the portfolio in North America.

Outside of North America, there's no question that our strong Snacking portfolio is well positioned to grow. We see tremendous opportunities ahead as we continue to leverage our global product platforms, our scale in Developing Markets and our route to market capabilities. We also have ample opportunities to grow in whitespace markets and in instant consumption channels.

With the addition of the Cadbury business, the North American Snacks portfolio now has the opportunity to pursue many of the same growth drivers and to become a truly ubiquitous snacking powerhouse.

Specifically, we'll leverage our global innovation platforms in Biscuits, Chocolate, Gum and Candy, and we'll also deliver significant growth from investments in direct-store-delivery and in instant consumption channels.

Now that we've rejuvenated the grocery brands within our North American portfolio, it can fulfill its promise of becoming a lean, mean center-of-the-store machine. It will leverage its category leading market position and continue to deploy its capabilities in innovation and marketing, while focusing on warehouse sales and distribution efficiency, but it will require very different investments and resource allocation.

Simply put, we've now reached a stage in our development where the global Snacks and Grocery businesses in North America would each benefit from standing on their own, and focusing on their unique drivers of success.

Today's announcement to create 2 independent companies will enable us to do just that. So how will it work? The Global Snacks business will consist of the current Kraft Foods Europe and Kraft Foods Developing Market Units, as well as the North American Snacks and Confectionery brands. As an independent company, it will have estimated revenues of approximately $32 billion and a strong growth profile in the top tier of its global peer group.

Approximately 3/4 quarters of revenues will be from Snacks and more than 40% will come from a diversified footprint in highly attractive developing markets.

The business will also have a strong presence in fast-growing and high-margin instant consumption channels. The non-snacks portion of the portfolio will consist primarily of powdered beverages and coffee, which have strong growth in margin profile in developing markets in Europe.

Key brands will include Oreo and LU Biscuits. Cadbury and Milka chocolates, Trident Gum, Jacobs Coffee and Tang Powdered Beverages.

Strategically, Global Snacks will focus on industry-leading growth by extending its global product platforms, leveraging the significant scale in developing markets, expanding in instant consumption channels and aggressively entering whitespace markets.

Global Snacks will leverage its cost structure through volume growth and improved product mix with disciplined investments in sales, distribution and manufacturing.

So what about the North America Grocery business? It will consist of a current U.S. Beverages, Cheese, Convenient Meals and Grocery segments, plus the non-Snack categories in Canada and Foodservice.

With approximately $16 billion in revenue, this business will continue to be one of the largest and most admired food companies in North America. Its portfolio will include many of the most popular brands on the continent, with the #1 branded position in 12 of its top 15 categories.

Just look at these key brands. Kraft Macaroni & Cheese, Oscar Mayer meats, Philadelphia Cream Cheese, Maxwell House Coffee, Capri Sun Beverages, Jell-O desserts and Miracle Whip salad dressing.

And as an independent company, the North America Grocery business will continue to leverage great marketing, innovation and leading market shares to deliver reliable revenue growth in line with its categories.

This company will concentrate on capital efficiency by focusing on 3 things: Low cost, enhancing margins and delivering reliable cash flow. It will use a variety of tools, including optimizing trade spending, Lean Six Sigma manufacturing and negative overhead growth. Its primary use of free cash flow will be to provide a highly competitive dividend payout. When managed in line with these objectives, we believe each of these portfolios will provide unique investment opportunities and attractive returns.

Creating 2 independent companies offers a number of benefits. Each business would focus on its distinct strategic priorities with financial targets that best fit its own markets and unique opportunities. Each would be able to allocate resources and deploy capital in a manner consistent with its strategic priorities in order to optimize total returns to shareholders. And investors would be able to value the 2 companies based on their respective operational and financial characteristics, such as growth and yields and thus, to invest accordingly.

We've successfully built 2 strong portfolios. As a result, we are now in a position to see the opportunity to create 2 great companies. Each will have the leadership, resources and mandate to realize its full potential.

I believe this is the best way to stage our businesses for long-term success, the best way for shareholders to value each business and the best way to ensure a bright future for our people around the world.

So to summarize today's news. We reported terrific results for the second quarter, continuing our strong business momentum. We're raising our outlook for the year and remain confident that we will deliver top tier performance for the full year.

Our virtuous cycle is working well in every region around the globe, so we're in a strong position to take the next logical step in our evolution, the creation of 2 highly attractive independent public companies designed to increase shareholder value. I'm sure you'll have many questions and as you can understand, we won't have all the answers today, but, of course, we'll provide further updates as appropriate in the coming months.

Operator, let's now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Andrew Lazar from Barclays Capital.

Andrew Lazar - Barclays Capital

The first question would be, it's always interesting to get a sense of sort of, why now. You're still obviously in the somewhat the integration phase obviously of getting Cadbury to be where you want it to be. You've got a lot of the cost synergies flowing through. Was it more a matter of do you think there's a way to just accelerate sort of whether it be the growth on the growth of your side of the assets and get more aggressively after the cost side for margin gains on the more cash generative North America Grocery business? Or was there something you saw into developing in the core business that made now the right time?

Irene Rosenfeld

Actually, Andrew, when you think about why now, this is going to take us about 12 months to implement, and so as we think about the Cadbury integration, it's well underway. Our International businesses are relatively untouched by this announcement and so they will continue to focus on delivering their results and completing the integration. And as we made, once we made this decision, every decision that we make going forward has some implications for the future state. And so it just made the most sense to just make it public and to begin to implement some of those actions as we move forward here. So it will take some time to actually separate the 2 businesses, but in the meantime, we can have our International businesses focus on completing the Cadbury integration, the bulk of the separation activity, of course, impacts our North American business and we can begin to make the decisions that are consistent with their future role and the future metrics that will be used to evaluate that business.

Andrew Lazar - Barclays Capital

And then to help investors start to get a better sense of how to evaluate these 2 sort of companies on their own, I realize a lot more information is still yet to come, but perhaps you can lay out just even with in initial way, the type of growth profile you see for each of these businesses, both sort of top line and bottom line, just to get a sense of the type of targets you think about when you look at these individual assets.

Irene Rosenfeld

Well, I think it's premature to talk about specific targets, Andrew. Obviously, we see them having different growth profiles. We're not in a position today to begin to issue guidance for 2012, but our long term growth rates and expectations have not changed. What we do expect is that as a consequence of the very different mandates and portfolios of these 2 businesses that we would see some different pro -- we would see some different profiles.

Operator

Your next question comes from Bryan Spillane of Bank of America.

Bryan Spillane - BofA Merrill Lynch

Just 2 questions. One is, I guess it's a follow up to Andrew's line of questioning in terms of why now. Just how much of the changes in the industry, there's been a profound set of changes affecting the food industry especially in North America over the last few years. So how much is the change and the pressures on the industry, maybe affected the long-term outlook for Kraft and just your outlook for the industry and if that had at all influenced your decision to do the split now?

And then second, the announcement this morning that Tim McLevish has decided to stay, or you've asked him to stay, and just what his role is going to be in the transition.

Irene Rosenfeld

Yes, so let me talk first about the long-term outlook. As I just mentioned, we see no change in the long-term outlook, our growth target of 5 plus organic revenue growth 9% to 11% EPS. We feel quite confident. In fact, given the updated guidance today, we feel quite comfortable that we will meet or exceed those targets in 2011. But the reality is as we look at the economic developments around the world, we would expect that there is likely to be some rebalancing in the profiles of the different regions. But as a consequence of being more targeted and more focused in defining the mandates of these 2 different businesses, we would expect better bottom line performance. So net-net, the long-term growth rate target in aggregates will not change. We would expect to see underneath that some rebalancing. But as I said to Andrew, we're not in a position today to begin to give guidance for 2012 and beyond. In answer to the question about Tim, I'm quite thrilled that Tim has agreed to postpone his departure from Kraft. He will actually lead the steering team that will oversee the creation of this 2 world-class companies, and we're delighted to have somebody with his background, his knowledge of Kraft and of the financial market to really bring some objective and transformational thinking to the creation of these 2 companies. Tim will be in the role until both companies are launched.

Operator

Your next question comes from Chris Growe of Stifel, Nicolaus.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

I wanted to ask in relation to the year, full year EPS guidance. You have pushed back the launch of Gevalia a little bit now. I think it was at least incorporated in your thinking about the drag from the -- the total Starbucks affect on your business. I just want to get a sense of kind of where that stands today. And then also, from just reading the press release, it looks like you have FX built-in from the first half of the year. But I do forecast some strong FX contribution in the second half of the year. Is that embedded in your guidance as well? I guess what I'm trying to understand, Irene, is -- I know you want to continue to reinvest back in the business as well, so how are you -- are you increasing investments, if you will, along with the strong underlying earnings growth performance?

Irene Rosenfeld

Well, we will continue to reinvest as appropriate. We have set very aggressive targets for our A&C. And as you've seen year-to-date, we're up quite strongly and we will be for the balance of the year. So you will see us continue to invest in the franchises -- in our franchises around the world. We feel terrific about the momentum behind our Gevalia launch. In fact, it's been stronger than we expected. And so we chose -- and to avoid disappointing our consumers, we chose to delay that launch until January 2012. But we are still quite excited about that opportunity, and we believe it will be a very strong brand for us as a complement within our North American coffee portfolio.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Was that a meaningful component of the $0.05 to $0.07 EPS adjustment that you had called out for the total coffee business this year?

Irene Rosenfeld

Actually, it was not. We were expecting to invest behind it. So it was -- the dilution was primarily coming from the absence of the premium coffee of Starbucks in that equation, not from -- so much from the launch of Gevalia.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Okay. And my final question is just in relation to what looks to be another round of pricing. I guess, you have won in Europe and you're done for the year, a little bit more on North America. Just a question for you, and I think you've kind of alluded to, at least in part of your comments about the elasticity. And I guess, I'm trying to understand if you see another further pickup in elasticity, if you will, in this next round of pricing, given the sequential price increases we've seen this year?

David Brearton

Yes. Chris, it's Dave. I mean, about 80% of the pricing has actually hit the shelf, so not all of it is in there. Not all of it has been there for a while, so it could still be a consumer reaction against the elasticity. And that's why we said at one point that we remain a bit cautious on the vol/mix, but we're pretty confident that we've got really good levers, whether that's in the End-to-End Cost Management, on our overhead program to manage through that and deliver the EPS on the year. I think, the key metric that we're going to keep tracking is market shares. The elasticity has been in line with our expectation. But importantly, our market shares are holding up well. And I think that's kind of the key metric we're looking at on the top line. We'll obviously have to keep on top of it, but it's pretty much so far, so good, I would say.

Operator

Your next question comes from Alexia Howard of Sanford Bernstein.

Alexia Howard - Sanford C. Bernstein & Co., Inc.

Can I ask about how you are saving the revenue synergies? I think last quarter, you talked about how Oreo and Tang have been launched into India. You've more than doubled the number of outlook for the Kraft-based products in Mexico and Brazil. Could you just give us a little bit more color about how you're thinking about how this will roll out, which brands, which countries, and how it's going to be phased over the next few years?

Irene Rosenfeld

Well, we are still confident in approximately billion dollars of revenue synergy estimates that we have laid out. If you recall, we had built in about 50 basis points of growth in our 2011 guidance due to revenue synergies. And as I mentioned in my earlier remarks, most of that hasn't really played through on our numbers, which is why we feel particularly encouraged about our results to date. We should see another 50 to 100 basis points as we look into next year and beyond, as we begin to capitalize either on putting legacy products through the route to market or entering white space market. It's about -- it's a combination of those 2 actions.

Alexia Howard - Sanford C. Bernstein & Co., Inc.

Great. And just a quick follow-up. The cost inflation this quarter, I think last quarter, it was around 7% to 8%, and that was your guidance for the year. Has it jumped up a little bit this quarter, or how is that playing out?

David Brearton

Yes, it's -- we said high single digits last quarter. We're saying low teens this quarter, and the difference really is coffee and dairy prices, so yes, they've gone up in the last 3 months. We're putting pricing in place, so we're feeling pretty good about it. But the total impact on our input cost has gone up since the last time we talked.

Operator

Your next question comes from David Palmer of UBS.

David Palmer - UBS Investment Bank

It's -- my understanding from another spin transaction, Ralcorp is doing some -- doing a spin itself that each part of the Newco -- of the new Kraft would be acquirable in stock even before the spin was consummated. And then post spin, again in your timetable presumably in 2013, the parts would be acquirable for cash as well. Is that your understanding with the help of your advisers, is that your understanding?

Irene Rosenfeld

I'm not quite sure what sort of a structure you're describing. What I will tell you is we feel very good about the opportunities to create these 2 terrific companies, and so that's our focus.

David Palmer - UBS Investment Bank

So there is -- you don't have an opinion about the tax -- the taxable nature of would-be acquisitions of the Spinco for instance, if someone were to approach you after this was announced, they couldn't buy it for stock near term or buy it for cash in 2013 without a tax event, you just -- no opinion on that?

David Brearton

Yes. We prefer not to comment on M&A generally. The spin we're proposing here is a tax-free spin and that's really what we're concentrating on for the next 12 months.

Operator

Your next question comes from Dave Driscoll of Kraft Foods.

David Driscoll - Citigroup Inc

I don't work for Kraft Foods, I work for Citigroup but I appreciate the thoughts. Irene, I just wanted to ask. First question was, was with this the plan all along once you were able to acquire Cadbury? I mean, was this kind of in the back of your mind from that date?

Irene Rosenfeld

Well, we were evaluating this for quite some time, David. Obviously, a transaction of this magnitude cannot be pulled off overnight. So as we acquired LU, as we acquired Cadbury, and we began to put the businesses together, and we continued to look at our strategic plan for this combined company, it was clear that we had very different businesses in the portfolio. And we believe that there could be great value created by unlocking those 2 businesses and allowing them to be free to pursue their own unique strategic priorities.

David Driscoll - Citigroup Inc

Can you comment on Wall-to-Wall? And what I want to get at here is, I was always under the impression that the theory on Wall-to-Wall was that Kraft in this combined form had a tremendous ability to create a sales force that had no peer in the United States with this Wall-to-Wall theory. When you disaggregate the entities, number one, it sounds like Wall-to-Wall would have to be dismantled, and then number two, does it really say something about the effectiveness of Wall-to-Wall?

Irene Rosenfeld

Well, the reality is -- one of the benefits of Wall-to-Wall was the opportunity to leverage scale across the portfolio, and there's no question that played out quite well for us. And as you remember, it was generating some revenue growth in excess of one point versus the control stores, but it did come with some complexity. And as we continue to revisit our sales structure, looking at the balance of effectiveness as well as efficiency, we came to believe that grocery -- there is still enormous benefit across the grocery portfolio to leverage the various types of the portfolio in events like Meal Solutions or Huddle for Hunger, those kinds of programs. But the focus of our grocery business needs to be on a low-cost warehouse selling system for center of the store products. It's very much focused on shelf management as distinct from a DSD system, which is highly focused on front of the store, impulse merchandising and immediate consumption channels. And so the differences of those businesses, we believe, allows us to create 2 various effective selling capabilities that will optimize the performance of both parts.

David Driscoll - Citigroup Inc

If I could sneak in one last question on the revenue synergies. You were commenting on revenue synergies for biscuits going into other countries. I also thought that after the Cadbury deal was done, there were some idea that maybe powdered beverages could also be layered upon those international operations. Does the revenue synergy thesis fundamentally change with the disaggregation of the company and is now the revenue synergy some lower number? Well, I know you probably don't have the number, but I would suspect it's lower.

Irene Rosenfeld

Not at all. I mean, in fact, one of the reasons why we believe strongly that Tang is an important part of the global snacking business is because of its opportunity and its strong presence, its growth potential, as well as its profit contribution in our developing markets. So we named a very important part of the equation. As you are aware, we have launched Tang in India on top of the chocolate distribution system. And you will see us continue to make those moves as we leverage our strong route to market capabilities around the world, but particularly in developing markets.

David Driscoll - Citigroup Inc

I didn't understand that Tang was going with that piece side, I do now.

Operator

Your next question comes from Eric Katzman of Deutsche Bank.

Eric Katzman - Deutsche Bank AG

I guess, maybe going back to the first question. I'm not exactly clear, Irene, why this is occurring. I mean, if the pieces aren't going to grow at a faster rate because they are more focused or because, I don't know, the tax rate efficiencies are greater with the global confection business, I mean, why do it? I mean, you know, I've been questioning your -- the growth rates for a long time when after you took over from Roger, you raised the growth targets, then we made the big Cadbury acquisition. So I guess, I'm not exactly clear as to why we should view this positively unless you think it's going to increase the growth targets or increase the amount of cash that can be brought back to investors, and then I'll have a follow-up.

Irene Rosenfeld

Yes, so I think for starters, Eric, we do expect that there will be the opportunity for GroceryCo to return more cash to investors, and for SnackCo to better capitalize on its growth by having a much more focused approach to managing those businesses. The rationale for separating these 2 businesses really comes from 2 places. Primarily, it's about operational benefits. Strategically, as we think about the very significant difference in the strategic priority, the focus of the grocery business on low-cost efficiency, particularly within a warehouse distribution system versus the profile of the global snack business, which is about high growth and essentially the leverage that comes from volume and mix growth, if you think about resource allocation, rather than having these 2 entities competing for an incremental dollar investment, we now have the opportunity to be able to use $1 within each of those companies to better achieve their objectives. I think from our customers' standpoint, they have very different go-to-market strategies, as I described a few minutes ago. The difference between a much more stable off-the-shelf management kind of approach to our grocery businesses as distinct from top zone, end-aisle merchandising, impulse purchasing of our snacking businesses, I think for investors, I think better understanding the growth drivers and the priorities for the use of cash, I think we have never been able to get credit for the tremendous snacking portfolio that we have within the company. I think the opportunity as we separate these 2 businesses for that to be much more visible and for investors to see the incredible profile that our global snack business has in aggregate and certainly relative to peers, I think, will serve as well. So ultimately, I believe the separation from an operational standpoint allows us to perform better. And then of course, there are clearly some financial benefits that we believe will come just as a consequence of the better clarity in the investment thesis between the 2 entities.

Eric Katzman - Deutsche Bank AG

Okay. And then as a follow-up, you have $27 billion of net debt today, that really hasn't changed much. I think, you've been kind of a bit below your targets, although I suppose working capital because of all the inflation is something that's affecting everybody. But how will the debt be allocated between the 2 entities? Because obviously, given how much leverage there is, that could have a pretty big impact on the equity value of either piece?

David Brearton

Yes. You're about right on the debt, and it has not come down from prior years, that's basically because we always have a back-half loaded cash flow. Our cash flow this year is actually pretty much in line with where it was last year, if you adjust for the pension contribution we did in the first quarter. So we'll see that debt come down in line with our deleveraging commitments in the back half. As it relates to the 2 companies, it's too early to speculate on exactly how much debt goes into each business. But I can confirm that both businesses will be investment grade, and both businesses will have access to CP markets, so we're going to make sure that the debt is balanced with a cash capability each of those companies bring.

Eric Katzman - Deutsche Bank AG

I mean, can I just sneak in one more? Does this mean that the Kraft brand is going to be split in terms of like cheese or -- and Tassimo? Is that being contemplated? Or would like -- is there some possibility that the North American grocery business would own like cheese in Europe?

Irene Rosenfeld

No. For the most part, the Kraft brand will go with the North American grocery business. But there will be a couple of trademarks like Tassimo, like Philadelphia for example, that will be shared. And obviously, we'll work out the details of that as we move forward. But for the most part, we detailed the brands within each portfolio. It's a pretty clean separation.

Eric Katzman - Deutsche Bank AG

Okay. Then sorry, just last thing. Does the timeline -- are we going to -- how do you see these updates in terms of when we'll know about the allocation of debt, when we'll hear from the IRS as to whether this is a tax-free spin-approved transaction? Can you just kind of give us a better timeline as to how we should think about this?

David Brearton

Yes, I think you'll see more -- sort of I'd say, we'll continue to update you as we go through the end of this year. But I think the IRS ruling probably won't be until some time early next year. I think we'll probably close out the books on the current structure. We'll probably give guidance on the current structure next year. But we'll start to give you much better visibility in to what these 2 companies will look like as we go through the year next year. As we get more clarity whether it's on the financial splits or the capital structure, et cetera, we will clearly share that with you. I know there will be a lot of interest in that, but I think you should be thinking in those kind of broad time frame.

Irene Rosenfeld

But our best guess, as we said, Eric, is this will take about 12 months.

Operator

Your next question comes from Jonathan Feeney of Janney Capital Markets.

Jonathan Feeney - Janney Montgomery Scott LLC

Irene, just one follow-up. You just mentioned on Eric's question that you didn't think you're getting credit as far as -- for some other growth. And I guess, one of the aspects of the market right now seems to me that some of the faster growing assets are trading sort of multiple lines right on top of the some slower growing assets. So if you could maybe give me some sense what you and your advisers think the comparable group for the snack company -- the presumably faster growth business, that includes Cadbury, would be as contrasted with what the comparable group for the grocery company would be. Because by my math, they're always in about 1.5 or 2 turns of EBITDA, and that really didn't get you too far as realizing value. So any help you can give me around that, I'd appreciate it.

Irene Rosenfeld

Well, let me start with the fact, it is a fact that the group trades in a fairly narrow range, so your observation is correct. But I do think that the facts are if you look at the specific companies, what you do see is that the global higher growth companies are trading in the upper teens, and many of the North American peers are tend to be trading in the lower teens, and so you do see a differentiation. But as we said, that is not the major motivation here. The big idea for us is to recognize that these are 2 very different portfolios that we believe can benefit with a focused mandate, and that will then drive resource allocation, capital allocation and ultimately, the metrics by which we would encourage investors to evaluate these 2 companies.

Operator

Our next question comes from Scott Mushkin of Jefferies.

Scott Mushkin - Jefferies & Company, Inc.

Not to beat a dead horse but, Irene, you said obviously, I pretty much understand the business rationale here, and I think it makes sense, that's my 2 cents. But it seems to me when you go to the board and you do something like this, you also have to say, hey, what's in it for shareholders, maybe even immediately -- that the valuations aren't where you are. So when you go to the board and get approval, which I don't think you have yet, are you going to give them any sense on what you think the assets are discounted because there may be some valuation gaps that you think exist in the business? Or is that not part of this process?

Irene Rosenfeld

Well, first of all, of course, we do have board approval, or we would not have announced this today. So we have had a very significant review of this strategy over the course of many years with our board. And the factors by which the board made the decision are pretty much the factors that we're sharing with you today. The reality that as we have taken a number of steps over the last couple of years to restore the health of our brands around the world, to transform the portfolio in our developing markets and Immediate Consumption Channel, we are now ready to take this next step, and it's on that basis that we made the decision.

David Brearton

Yes. This is Dave. We clearly have board approval for the announcement of our intent to create the 2 companies. We will need to have separate approval once we have the IRS ruling and we have worked out all the details again, so it's kind of an approval of 2 steps.

Irene Rosenfeld

But I would say that we certainly believe that the results that we have delivered to date and the significant opportunities that we believe can be created by separating these 2 businesses should create -- should merit a premium multiple from where we stand today.

Scott Mushkin - Jefferies & Company, Inc.

I mean, that seems to me as I did the quick math, I mean, it seems like you separate these guys apart, but that there was an inherent discount involved in the current valuation. But it seems like maybe that wasn't a massive or big part of your thought process, and I was actually a little surprised by that. I mean, I completely understand the business aspect, but there also seems to be a financial aspect that's pretty compelling as well.

Irene Rosenfeld

Yes. We agree.

Scott Mushkin - Jefferies & Company, Inc.

Okay. Then the second thing is -- and thanks for the clarification on the board stuff, I guess, I must have misread it a little bit, but I think I get it now. The second thing would be, I know last quarter, you gave us -- I think it was last quarter or the quarter before, some initial kind of things that we're going on in India and how Oreo was doing there. I was wondering if you could give us kind of a detailed update on something like that? And I'd love to have a follow-up on India and how some of the synergies -- these revenue synergies in particular are working and where we are maybe on the revenue synergies that you promised where we are there, that would be great.

Irene Rosenfeld

Well, our Indian business continues to be on fire. In fact, it was up 46% in the quarter, so we feel terrific about that, and actually the key driver underneath that is Cadbury dairy milk, which grew over 60%, I think, in the first half. So we feel terrific about the progress within India. It's a critical growth market. It was one of the most -- one of the important aspects of the revenue synergies, as we described when we made the Cadbury acquisition. But we feel terrific about the overall performance of all of our developing markets. As I talked about each of our global categories, within each of those, we feel very good about the aggregate performance. But within each of those categories, the performance within developing markets is just standout, and most of it is really about investment in our core franchises. And that's really what's driving the growth and gives us great confidence, that going forward we will continue to see benefit.

Scott Mushkin - Jefferies & Company, Inc.

And I just wanted one clarification to the last question I had. When you went to the board to get the approval that you got, did you have to give them financial thoughts too as well what the discount was, or was that part of the process? Just so I'm clear on that. I mean, really maybe...

Irene Rosenfeld

Well, I think you can understand it was a very thorough review that predicated on how we believe these 2 businesses could operate differently under the separation scenario. And as we said, we believe that we can create great value for our shareholders as a consequence of having a much more focused mandate and the ability to allocate our resources and our capital much more effectively.

Scott Mushkin - Jefferies & Company, Inc.

You want to give us the discount you thought the assets were traded at?

Irene Rosenfeld

Well, I think, you can actually look at the market multiples and might be able to estimate that yourself.

Scott Mushkin - Jefferies & Company, Inc.

Yes, we are going to do that. I just thought to give it a shot. Okay.

Operator

Your next question comes from Ed Aaron of RBC Capital.

Edward Aaron - RBC Capital Markets, LLC

I see you've laid out some of your other benefits from the spinoff. But I was hoping you could maybe address any of the synergies that you might end up seeing in terms of purchasing or corporate overhead and so forth?

David Brearton

Yes. I think we've obviously been through that and looked at it. We don't see huge synergies. I mean, both of these companies are enormous $32 billion and $16 billion each, and they still got a fair bit of procurement scale. They didn't share a lot of backroom, and that's why we were able to make this decision. It wasn't a huge amount of backroom, sharing beyond sort of finance systems type of things. But they had a different route to market, which is the biggest piece of the cost. So yes, there will be the synergies. We also think there'll be some operational benefits coming out of separating these 2 and having them focus on their specific routes to market and their specific business fundamentals. We think those benefits will actually offset with the synergies. So on balance, we're looking at this as a net positive. But yes, there clearly will be some of the synergies in some areas of the P&L.

Edward Aaron - RBC Capital Markets, LLC

Okay, and would it be fair to kind of allocate, like the depreciation and the corporate overhead roughly, proportionately to the size of these 2 businesses from a revenue perspective?

David Brearton

I think it's a bit early to get into it, but I would say snacks growing at a higher pace, so you can assume it'll have a higher capital requirement in terms of CapEx expenditures, and grocery at a lower pace, will have lower CapEx expenditures, but we can't really get into details at this stage.

Edward Aaron - RBC Capital Markets, LLC

Okay. And then just one more follow-up. On the North American snacks businesses, there kind of been a relative laggard in your portfolio recently. And I guess, there's a bit of an issue around gum there. But can you just maybe address that at a high level and talk about how much the recent performance of that business might be kind of factoring into some structural changes that you see where you might pick up some benefits with this new structure?

David Brearton

Well, I think, the U.S. snacks business this quarter was actually mostly a gum story. I mean, biscuits had a terrific quarter. It was up about 3%. Its top 5 brands were up about 6%. We've sort of gotten A&C investment back on track, and we've got some good innovation. So biscuits did well. Nuts was up about 6% with a nutrition platform. Candy was up about 9%. So the U.S. snacks business this quarter is really a gum story. And as Irene mentioned earlier, gum in the U.S. is down about double digits. We have some plans in place to get that back on track, and we expect a significant rebound in the back half. But that's really about the story this quarter. Ongoing, clearly, the idea that we can focus the U.S. snacks business on a DSD route to market, the impulse channel, the hot zone and leave the grocery business to be the center of the store machine, that is something that we would expect to have operational benefits going forward, but that's not in and of itself a reason to drive this bigger transaction. That is one of the benefits we would expect though.

Operator

Your final question comes from Diane Geissler of CLSA.

Diane Geissler - Credit Agricole Securities (USA) Inc.

Can you just talk about -- it's a very long period of time between the announcement and when you expect to complete the transactions, what you'll be doing in the interim to maintain talent, keep people at the organization who you want to keep at the organization who might be feeling like they're being spun off?

Irene Rosenfeld

I start with the fact that we think this is an exciting opportunity for employees around the world. And a lot of what we're going to be doing in the coming weeks is helping our employees to understand the opportunity that is available to them as a consequence of creating these 2 great companies. But we have a lot of work to do in the coming months. But our most important focus is to ensure that we will remain one company until we spin. And so it is critically important that we keep our employees focused on delivering on our results in 2011 and then into 2012. But obviously, ensuring that they understand the rationale and they see the opportunities that are available to them as a consequence of the separation will be a key part of our communication strategy to them.

Diane Geissler - Credit Agricole Securities (USA) Inc.

And what should we be thinking about in terms of you communicating who will be running the new company, the spun company?

Irene Rosenfeld

Well, obviously, we have a number of decisions to make in the coming months. But we've got an incredibly talented management team around the world, and they're the ones who got us to where we are today. And so we have a very rich bench from which to populate these 2 companies, and we will keep you posted as we move forward here.

Operator

At this time, there are no further questions. I'll now turn the call back to Mr. Jakubik for closing remarks.

Christopher Jakubik

Thank you very much, and thanks, everyone, for joining us a bit earlier than anticipated this morning. For those of you who have additional questions, Mike Mitchell will be available to take media calls, and Dexter Congbalay and myself will be around for any of the questions from any of the analysts. So thanks very much for joining us, and we'll speak to you soon.

Operator

Thank you for participating in today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Kraft Foods' CEO Discusses Q2 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts