The second leading snack producer, Kraft Foods (KFT), has received a lot of criticisms of late from activist investors. Among these investors are Trian with 0.98% ownership, Pershing Square with 1.26% ownership, and, surprisingly, Berkshire Hathaway at 5.63% ownership.
Put differently, the large-cap company has been pressured on all sides: From a hedge fund with strong experience in turning around food businesses, from another hedge fund that is quickly rising to stardom, and from a legendary value investor. In addition, more than a quarter of the shareholders are value or deep value-oriented.
While Warren Buffett usually invests in strong companies and supports incumbent management, he has challenged Kraft's recent action to acquire Cadbury PLC through new shares. In 2007, Kraft purchased shares for $33 and just last year it started selling them for $27. This contradictory action was both unnecessary and value-destructive. The company is the maker of Oreo, Nabisco goods, Cadbury chocolates, Oscar Mayer meat, and Trident gum, among other household names. With its strong portfolio of brand name products, Kraft simply does not need more acquisitions.
Accordingly, the board has recently decided to split the company into two different businesses. The larger of the two will provide for high-growth globally and will market snack products. The other provides for high margins in the North American grocery business.
I find that this decision will grow value in the long-term for Kraft as it will enable the producer to chiefly focus more on pushing products into the emerging market. I have revised my estimates for growth in developing markets from 19% to 26% for the next year. ROIC will also increase appreciably.
The risks of this split is that there will be issues of tax leakages, capital inefficiency, and trademark challenges. Costs in increasing management size will further drag down net income, but I do not see these factors offsetting growth from more effective business expenditures.
Analysts currently rate the stock between a "buy" and a "strong buy". Consensus estimates for EPS are that it will grow by 12.4% in 2011 to $2.27 and then by 11% and 12.3% in the next two yeas. I forecast the company's revenue growing by 12%, 3.7%, and 5.1% in the next three years. Kraft also offers an attractive dividend at 3.4% and I expect its enterprise value to trade at roughly 8.1x 2013 EBITDA.
From a competitive standpoint, I believe that the planned breakup also strengthens the company's market position. While I find that Kellogg will struggle in the coming years to grow its customer base, I believe that strong value creation in Coca Cola (KO) and Pepsico (PEP) will not significantly impact Kraft's business. In short, I expect Kraft to be a long-term winner in its market.