Mondelez (NASDAQ:MDLZ) has been facing great challenges during the last 3 years. To be sure, it has experienced declining sales for 11 quarters in a row. Nevertheless, the stock is still trading around its all-time highs. Therefore, as the stock seems rock-solid regardless of the underlying business performance, it is only natural that some shareholders have become complacent. In this article, I will analyze why I recommend staying away from the stock.
First of all, the declining sales for 11 consecutive quarters indicate that the business model of the company is facing strong headwinds. The competition has been heating in the sector, as consumers now have more choices than ever. As evidenced from the results of the company, the management has not been able to put a stop on the erosion of its business by competition.
Instead the management has adopted its own unique strategy of reporting results. More specifically, in its last earnings release, the company spent 8 pages to define every single financial metric and specify which items it excluded from its results. For instance, its adjusted earnings per share excluded the spin-off costs, two restructuring programs, losses from Venezuela, losses from goodwill and intangible assets and several other items. It is worth noting that the two restructuring programs that were excluded lasted from 2012 to 2018. Therefore, these costs are as recurring as they can get and hence it is highly misleading to treat these items as special.
Thus the management of Mondelez excludes numerous items and is satisfied with its "adjusted" performance but, unfortunately for the shareholders, success is not determined that easily. It is actually the combination of all these external headwinds that makes it difficult for companies to keep growing. If all the headwinds were excluded, then most companies would keep posting excellent results for decades. Of course no one can predict for how long the market will continue to evaluate Mondelez based on its adjusted metrics. However, it is my principle to never invest in companies that define their own metrics to report their results. This is in line with the principles of Buffett as well. If the market suddenly decides to price the stock based on its reported figures, the downside potential will be huge.
As if the business challenges were not enough, the company is also making very poor use of its earnings. In the first 9 months of the year, while the company has earned $1.57B, it has returned $2.6B to its shareholders including $1.8B in share repurchases. Therefore, it has not retained any earnings to invest in its business to tackle the great challenges it is facing. Moreover, the company spent more than its earnings on markedly expensive share repurchases, which do not enhance shareholder value. To be sure, the stock is trading at a trailing adjusted P/E=18 and a price/book value=2.3. These valuation metrics and the negative trend of sales do not justify by any measures such aggressive share repurchases. Instead experience has shown that managements usually resort to aggressive share repurchases only to mask deteriorating business performance.
The shareholders of Mondelez should also be alarmed by the recent failed attempt of the company to acquire Hershey (NYSE:HSY). Hershey has failed to grow in the last 3 years and is trading at a remarkably high trailing P/E of 26. Mondelez attempted to acquire Hershey at an even higher valuation of $107 per share, which corresponds to a P/E of 28. As the valuation of Hershey is extremely high, particularly given its lack of growth, the attempt of Mondelez indicates that its management is having a hard time finding more efficient ways to return to growth. All in all, this desperate move does not bode well for the future growth prospects of Mondelez.
On the bright side, the company recently announced that it is planning to make a major expansion into the US chocolate market. Moreover, the company is also expanding in the Chinese market, whose value is estimated around $2.8B. If the management proceeds cautiously and successfully in these markets, it may be able to put a stop on the declining revenues. Nevertheless, the company still has a long way to go to return to a trajectory of sustainable growth.
To sum up, I do not recommend purchasing Mondelez due to its deteriorating business, the poor moves of management and the special way it reports its results. It is Buffett's (and my) principle to never invest in companies that report their earnings in a very complicated and different manner from their peers. Of course this does not mean that Mondelez will plunge any time soon. The market may continue to price the stock based on its adjusted figures for many years. Nevertheless, when the market shifts its focus on the reported (instead of adjusted) results of the company, the downside risk will be substantial.
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.