3 Came To Dinner: Kraft, ConAgra And Hormel

Includes: CAG, HRL, MDLZ
by: Ron Sommer

It is obvious we all need to eat and so it would seem that food companies are the ultimate defensive play for the investor. At its heart, the food industry is a commodity business much like oil, timber or metals. Underlying commodity prices are influenced by many factors including weather and geopolitical turmoil. A late freeze damages the orange crop in Florida and supply is decreased. World coffee prices are changed because of a coup in Africa. The price of feed corn rises because farmers switch to crops better suited to biofuel production. In some ways, the food industry is much like the retail fashion industry. Demand may change because of new fads or changing health concerns.

Of the three subject companies, Kraft (KFT) is by the largest with sales of $53,450 million and a market capitalization of $68,445.9 million. Hormel (NYSE:HRL) is the smallest with a market capitalization of $7,748.33 million and LTM sales of $7,895.1 million. To meet market challenges, each of these companies has a strategy of acquisition, and in the case of Kraft, to split the company.

Kraft Foods is a leading global manufacturer selling its products in 170 countries. Its portfolio includes such iconic brands as Oreo, Nabisco, Cadbury, Maxwell House coffee, Oscar Meyer and the ubiquitous Kraft cheese brand. About half of the company's revenue originates in North America and the remainder is about evenly split between Europe and developing markets. Confectionary and biscuit products generate about 50% of revenue.

Kraft is splitting into two separate and independent companies. One company will assume the snack business while the other will take the grocery market. The split will cost about 1,600 jobs and is expected to be completed by the end of 2012. In other recent news, Kraft announced a strategic partnership with the Israeli company, SodaStream (SODA). This partnership will introduce carbonated beverages to Kraft's product line.

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Kraft expects to release its full 2011 operating results February 21. The company is expected to announce that revenue is up about 10%; organic growth by 6.5% and diluted EPS at $1.95. At this level of diluted EPS, growth is indicated at 35% over 2010.

Analysts like Kraft and rate it "overweight." Target prices range from $35 to $45 with a median target price of $41 and an average of $40.74. By our own estimate, Kraft has a value of about $36.75. From our point of view, Kraft has more negatives than positives. Valuation metrics based on trailing enterprise value are very high as are forward PE ratios. We also see relatively high levels of debt and we are concerned with the negative working capital situation. Further, returns on assets, equity and invested capital are below the respective five-year averages.

The company is trading near its 52-week high. It may be that by splitting the company, Kraft can unlock value for shareholders. The current dividend yield is attractive but should not be decisive.

ConAgra Foods (CAG) is our second-largest company with a market capitalization of $11,192 million, small in comparison with Kraft, and sales of $12,827.2 million. ConAgra also has in its portfolio a number of household names including Marie Callendar, Banquet, Chef Boyardee, Egg Beaters, Healthy Choice and Hebrew National. ConAgra has two reporting segments: Consumer Foods, which contributed in FY2011 $8,002 million or 65% of total sales and Commercial Foods, which contributed the remainder.

ConAgra is in restructuring mode. It is closing plants and disposing of assets even as it acquires other companies. Most recently, ConAgra agreed to acquire Del Monte Canada. Other recent acquisitions include American Pie and Elan Nutrition. The company also divested Gilroy Foods and Flavors.

Fewer analysts follow ConAgra than do Kraft. Those who do rate ConAgra "overweight." The analysts provide target pricing in the $24 - $30 range with a median target of $28 and an average of $27.73. Our target value is $23 - $24. ConAgra seems to be trading at reasonable multiples of enterprise value and at a premium to forward PE. The company offers current returns on assets, equity and invested capital above its five-year averages. Growth rates are challenging and debt levels may be too high for this company. ConAgra has been hitting new 52-week highs. The market price may be getting ahead of the fundamentals.

Hormel Foods is the smallest of the trio. The company operates in five segments: Grocery Products, Refrigerated Foods, Jennie-O Turkey Store, Specialty Foods, and All Other. The company's brands include Spam, Valley Fresh, Farmer John, and Herb-Ox, among others. Although pork and turkey remain the major raw materials for Hormel products, the Company has emphasized for several years the manufacture and distribution of branded, value-added consumer items rather than the commodity fresh meat business. The Company has continually expanded its product portfolio through organic growth, new product development, and the completion of numerous strategic acquisitions.

Hormel is a low debt company selling at a reasonable multiple of enterprise value to EBITDA but weak in EV to free cash flow. Forward PE ratios indicate that the market expects fairly robust growth in the coming years. We see Hormel having a target valuation of $32 - $33. Analysts are ranking Hormel a "hold" and have price targets in the range of $25 - $32 with a median target of $27 and an average of $28.07. The company is showing strong returns on assets, equity and invested capital. Returns, at the current level are above their respective five-year averages. Hormel's returns are, generally, better than those from Kraft or ConAgra. Hormel's dividend is yielding about 2.1% but is growing nicely.

Disclosure: I am long CAG.