What is the most popular cookie in history? The only one to have sold more than half a trillion (500 billion) cookies to date? The one that is the most popular in the world including the United States, Europe and China? The one that has been around since 1912? It is the Oreo cookie, produced by Kraft Foods Inc. (KFT).
When a company with a product as impressive as the Oreo cookie launches a new product, the implication of the ultimate impact of such a move cannot be ignored. Kraft recorded revenues in excess of $42 billion in 2010, is expected to generate revenues in excess of $56 billion in 2012, and owns tens of iconic brands. 40 of these brands have been around for more than a century, and at least 12 brands generate annual revenue of over $1 billion each.
Kraft is expected to generate earnings of $2.28 per share in 2011 and $2.53 per share in 2012, yielding an attractive P/E ratio given current low interest rates. In addition, dividend yields currently stand at about 3.36%.
The new Triple Double Oreo cookie has two important implications:
- Product Innovation: Product innovation is a term typically applied to technology companies, and not to food companies. However, for Kraft to take a 100-year old product that continues to be popular worldwide, and use it to derive an innovative new product that can potentially thrive due to its predecessor's success, that shows that Kraft is attempting an aggressive growth strategy.
Although there is a risk of cannibalization of the traditional cookie, combined sales are still likely to increase. Will the "sequel" be as popular as the original? Probably not, but that does not mean that the sequel cannot generate respectable revenues.
- Pricing Diversification: When a product has such deep market penetration, such as the original Oreo cookie, price changes to improve margins can be a risky business. However, a newer product that seems to be more sophisticated, such as the Triple Double Oreo cookie, can build-in higher margins and consumers may be willing to go along for "sophistication" sake.
What does all this mean for the future of Kraft's stock price?
Given the current volatile nature of the stock market, the current fears for an economic slowdown and possible recession. The respectable dividend yield of 3.3% provided by Kraft's stock, its growth potential due to product innovation and possibly pricing diversification, the defensive nature of the stock for being a food company. In addition, Kraft's announcement of splitting the company into two publicly traded companies to unlock value, there is a compelling argument to buy shares at current price levels.
How about recent announcements by other food companies for lowering retail prices, such as Smucker's (SJM) coffee prices?
Such development is actually positive. Smucker lowered its coffee prices due to a drop in coffee bean prices. A lowering of prices due to a drop in commodity prices is typically healthier than raising prices due to an increase in commodity prices. Why? Because the latter typically erodes margins, as commodity price increases are not typically fully passed on to consumers through a retail price increase. Furthermore, such increases can possibly result in loss of quantity sales, as consumers economize and possibly shift to alternate products.
On the other hand, when commodity prices drop, it is unlikely that food producers will pass the entire drop to the consumers through lower prices. Hence, margins can increase and sales can increase as consumers can possibly consume more due to the lower price.
A reasonable strategy would be to buy Kraft's shares at current levels of $34.40, and possibly hedge downside risk by buying Kraft's March 2012 out-of-the-money puts, with a strike of $31, priced at about $1.14.