After posting an impressive 21% return in 2015, the maker of Oreo cookies is down 8.6% during the first few trading days of 2016 due to market sell-off and rating downgrade from a few sell-side analysts. The prevailing concerns over global economic growth, the risk of further weakness in emerging currencies, and uncertainty over the profitability of coffee joint venture are putting pressure on the stock price. However, these are short-term concerns, and the management's aggressive measures to improve the profit margins should enable Mondelez International (NASDAQ:MDLZ) to remain resilient in the tough and competitive scenario.
Mondelez, one of the leading confectionery companies in the world, has a broad portfolio of power brands including Oreo, Ritz, belVita, Cadbury Dairy Milk, Trident gum, and Tang. Mondelez generates more than $34 billion in sales revenue with the help of several billion-dollar brands, but the profit margins of Mondelez are low as compared to most of the peer companies. The following graph compares Mondelez's margins profile with some of the major food & beverage companies and shows that the company's operating and net margins have room for further expansion.
Source: SEC filings
Like several other food & beverage companies, Mondelez is also pursuing cost-reduction program to boost the profit margins, and the strategy is working pretty well. During the third quarter, Mondelez witnessed an increase of 180bps and 170bps in its adjusted gross and operating margins, respectively. The margins are likely to increase further steadily in the coming quarters primarily due to optimization of global supply chain & manufacturing network and zero-based budgeting. Moreover, productivity gains and deeper cuts in 2016 budgets under the influence of activist investors will also boost the adjusted operating margin close to peers in the coming quarters.
Mondelez's increased focus on the U.S. market for better revenue mix should also have a positive impact on profitability in the absence of currency resistance. In this regard, shifting and doubling the capacity of Enjoy Life Foods, which is expected to complete by the third quarter, amid growing demand will allow the company to enhance the efficiency and to gain market share in the niche product category in North America. Though Enjoy Life Foods contributes a small portion to the top-line, the fast growing allergy-friendly and gluten-free snacks business is an important growth driver for Mondelez in the long-run. Mondelez's $81 million acquisition added $25 million incremental revenue for the first nine months of 2015.
The gluten-free products market is likely to reach $7.6 billion in 2020 from $4.63 billion, which translates into a CAGR of approximately 10.4%. While Boulder Brands (NASDAQ:BDBD), General Mills (NYSE:GIS), Kraft Heinz (NASDAQ:KHC), and Kellogg (NYSE:K) are some of the major gluten-free food companies, the expansion of production facility, the launch of on-the-go protein snacks and top-selling gluten-free baking & chocolate cookies will help Mondelez to gain market share. Thus, even a single percentage market share could almost double the revenue from gluten-free products over the next five years.
Despite steadily growing confectionery and cookie industry, Mondelez's sales revenue declined 12.3% to $22.3 billion during the first nine months of 2015. The soft volumes and currency headwind hammered the top-line growth, and the strengthening of the U.S. dollar resulted in a massive $3 billion loss of top-line over the same period. Mondelez's exposure to international markets is very significant, in fact, the company earns only 23% of total sales revenue from North America. However, the solid momentum of core brands derived 3.4% increase in organic sales revenue during the first nine months of 2015. In the coming quarters, the overall ease in currency headwind and better management of foreign exchange risk will restrict the impact on revenue and earnings. Thus, the expected double-digit earnings growth in 2016 depicts that Mondelez is not pricey at these levels.
Mondelez's well-diversified product portfolio across different growing product categories accelerates decent sales growth. Driven by steady demand in the developed as well as emerging countries, the global confectionery and cookie market is expected to grow at a CAGR of 2.68% and 4.21%, respectively, by the end of 2019. Although the favorable industry dynamics and demand for power brands will continue to accelerate profitable growth in the long-run, the core volumes in Brazil and Russia may remain subdued in the near-term. Given that Mondelez earns 40% of sales from emerging markets, the economic slowdown in Brazil could limit the overall growth from emerging markets. However, the new investment in Nigeria and new product launch in the other emerging markets should offset the negative impact to some extent.
With the changing snacking habits in the U.S. and Europe, Mondelez trying to align its product portfolio according to consumer preferences. In this regard, 10% reduction in sodium and saturated fats level and 25% increase in whole grains level by 2020 will have a favorable impact on volumetric growth, particularly in North America and Europe. While advertising will play its role, the expansion of Oreo in Russia and belVita in China will be the growth driving products in the coming quarters.
Despite its focus on the long-term targets and bright growth prospects, Mondelez is certainly not the best choice for the investor looking for high yield stock. Since 2013, the dividend yield has declined from around 2.85% to current level of 1.66% primarily due to impressive 56% increase in share price. Mondelez has hiked the dividend three times at an average rate of 9.4%, and the most recent increase of 13.3% was due to the gain on the coffee deal. The improving cash flow position due to cost savings and margin improvements will support the dividend growth, but the company will hike the future dividend at a rate close to its historical average to allow itself to invest in the long-term growth opportunities.
Mondelez is trading approximately 15% below its 52-week high, which depicts the current valuation level is very reasonable, and downside risk is limited. The stock's forward price to earnings multiple of 20.2x is in line with the consumer staples sector forward price to earnings multiple of 20.1x, and well below the company's own 5-year historical average of 25.3x. That said, the estimated double-digit earnings growth over the next five years and growing dividends will provide healthy returns to long-term shareholders. Thus, my opinion about Mondelez is still positive.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.