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Many defensive investors may be naturally attracted to food producers due to their high dividend yields and low betas. But digging beneath the surface, one finds limited upside and overly speculative assumptions on demand. Kraft Foods (KFT), General Mills (NYSE:GIS), and ConAgra (NYSE:CAG) are three companies worthy of consideration despite business pressures.

From a multiples perspective, ConAgra is the cheapest of the three. It trades at a respective 14.6x and 13.5x past and forward earnings. It also offers the highest dividend yield at 3.5%. General Mills and Kraft, meanwhile, trade at a respective 17.1x and 20.5x past earnings. Perhaps ironically, the most expensive company on the market receives a "strong buy" rating on the Street while the least expensive company receives a "hold" rating.

At the second quarter earnings call, General Mills' CEO, Ken Powell, noted favorable developments:

"Through the first half of this year, our sales in [Bakeries and Foodservice] are up 12%. That growth has been led by price and mix, but pound volume also is up 1% year-to-date. We are continuing to outperform foodservice industry trends by focusing on the most resilient customer channels. Our sales with Foodservice Distributors grew 8%, driven by good performance on our hot breakfast products like Pillsbury Mini Pancakes and French Toast. Our sales in convenience stores were up 10%, led by recent new product launches in the channel like Nature Valley Recharge bars and Fiber One Brownies. And our good growth in bakeries and national restaurant accounts reflects particularly strong performance from in-store bakery items…

We continue to expect good sales growth for Bakeries and Foodservice for fiscal 2012 in total. We still expect a mid-single-digit decline in segment operating profit as planned, because we are lapping particularly strong levels of grain merchandising earnings last year."

The second quarter was nevertheless 3 cents below consensus at $0.76. Part of the problem stemmed from input inflation that eroded margins. Another problem was that inventory reductions resulted in lower absorption of fixed costs. Either way, the food producer was weak in addressing macro issues compared to Kraft.

In order to boost demand, the company is planning to unveil and promote several new products: Nature Valley Granola Thins, Greek yogurt, Fruit Twists. Since Yoplait was down 6% for the quarter, I am not terribly optimistic about the potential of Greek yogurt. The planned launch of lactose-free Yoplait will, however, have strong demand due to the effect of a brand-name product targeting a substantial niche market. Note that lactose-free dairy products have been growing at double digit rates; thus, the upside is meaningful.

Consensus estimates for General Mills' EPS are that it will grow by 4.8% to $2.60 and then by 8.8% and and 8.1% more in the following two years. Assuming a multiple of 18x and a conservative 2012 EPS of $2.77, the rough intrinsic value of the stock is $49.86, implying 24.4% upside. If the multiple were to decline to 15x and 2012 EPS turns out to be 12% below the consensus, the stock would only decline by 6.8%.

Kraft has even greater upside with its record of strong performance. During the third quarter, the company had solid growth in all geographies and price increases did not result in a meaningful volumes decline. In fact, the price increases offset higher raw material costs and grew operating income by the double digits, sequentially. The S&P recently rated Kraft's $800M notes BBB-.

Consensus estimates for Kraft's EPS are that it will grow by 12.4% to $2.27 in 2011 and then by around 11.1% in the following two years. Assuming the multiple declines to 19.5x and a conservative 2012 EPS of $2.46, the rough intrinsic value of the stock is $47.97, implying 27.7% upside.

Source: Why Kraft Is More Undervalued Than General Mills Or ConAgra