Kraft Foods Looks Like a Buy After Split Announcement

Breaking up is hard to do, unless you're Kraft Foods (KFT). The company announced Thursday that it would split into two separately trading stocks in a tax-free spin-off to shareholders. Kraft will separate the fast growing global snack foods business, including brands such as Nabisco, from the slower growing but higher margin North American foods division. Shareholders of Kraft will receive shares of the new company representing the North American business. The timing of the announcement couldn't have come at a worse time. Despite the split being a very positive development, shares were unable to stay in positive territory during Thursday's market rout. After initially surging on the announcement, shares closed down $0.56 for the day. The stock did regain some ground on Friday, closing up $1.09 (3.23%) at $34.87.

The split was likely pushed by activist investors such as William Ackman of Pershing Square Capital Management and Nelson Peltz of Trian Fund Management. Ackman and Peltz own 1.3% and less than 1%, respectively. Warren Buffett, Chairman and CEO of Berkshire Hathaway (BRK.A, BRK.B), is Kraft's largest shareholder with 6% of the company. He has stated that he supports the decision.

The decision to split the company does seem like the most likely way to unlock shareholder value. The company has been unable to convince shareholders that its fast growing snack foods business makes it deserve a higher stock price. Kraft is definitely a more defensive stock, but the company has been seeing fantastic growth throughout the emerging markets. By separating the company, investors will see a clear difference. The snack foods business will be about growth and increasing overseas market share while the North American food business will be a high-margin cash cow. The North American business will likely pay a relatively high dividend, keeping with its defensive nature. Kraft estimates that the global snack food business will generate revenue of $32 billion and the North American foods business will generate revenue of $16 billion. Kraft will take approximately the next year and a half to set the terms of the split and gain the necessary approvals. The split should occur by the end of 2012.

Kraft also reported Q2 earnings on Thursday. The company stated that it grew revenues by 13.3% to $13.9 billion. Operating income grew 6.2%. The company posted diluted EPS of $0.55, beating estimates by $0.04. The company raised its 2011 outlook for operating EPS of at least $2.25.

Click to enlarge
(Click to enlarge)

Kraft has a forward P/E ratio of less than 15. The company has grown revenue at an annualized rate of 7.6% over the last five years. The dividend yield is a solid 3.33%. Kraft has grown the dividend at an annualized rate of 5.9% over the last five years. The company pays out 67% of cash to shareholders.

By splitting the company, Kraft appears to be on a track to unlock the value in its shares. Kraft has always been an attractive defensive stock due to its solid dividend. Growth has taken a back seat in shareholders minds. Now, shareholders may be able to have their cake and eat it too.

Disclosure: I am long BRK.B. I may initiate a position in KFT within the next 72 hours