As an IR consultant, I believe that it is only a matter of time before the Street catches onto the value of under-followed, but deserving, food / snack brands like New Dragon Asia (NDAC.PK) and Golden Enterprises (GLDC). Barring a change in press coverage, the attention will be placed on Kraft Foods (KFT). This iconic food producer stands to gain significantly from the materialization of a macro recovery. In this article, I will run you through my DCF analysis on Kraft and then triangulate it with an exit multiple calculation and a review of the fundamentals compared with General Mills (GIS) and Kellogg (K).
First, let's begin with an assumption about revenue. Kraft finished FY2011 with $54.4B in revenue, which represented a gain of 10.5% off of the preceding year. Analysts model a 9.3% per annum growth rate over the next five years, which is more than 100 bps below what is expected for the S&P 500 (SPY).
Moving onto the cost side of the equation, there are several items to consider: operating expenses, capital expenditures and taxes. I expect cost of goods sold to eat 64% of revenue versus 22% for SG&A, 1.2% for R&D, 30% for taxes, and 3.4% for capex. These figures are all around historical 3-year average levels.
We then need to subtract out net increases in working capital. I model accounts receivable as 13.3% of revenue, inventories as 16% of COGS, accounts payable as 11.5% of OPEX, and accrued expenses as 37% of SG&A.
Taking a perpetual growth rate of 3% and discounting backward by a WACC of 7% yields a fair value figure of $49.96, implying 30% upside.
All of this falls under the context of strong progress:
Why am I so confident? It's because our businesses in every region around the world are benefiting from a virtuous growth cycle, and as a consequence, our results are outpacing our peers. In 2011, our Power Brands grew 8%. This in turn drove organic net revenue growth of 6.6%. That's a significant improvement over top line performance in 2010. Then, organic revenue rose a little over 3%, fueled by Power Brand growth of more than 6%. And we delivered those results during an unprecedented environment of economic and political unrest, as well as skyrocketing input costs.
From a multiples perspective, Kraft is also fairly attractive. It trades at 19.3x past earnings but only 13.8x forward earnings. General Mills trades at a respective 16.5x and 14x past and forward earnings versus 15.6x and 13.9x for Kellogg. Assuming a multiple of 17x and a conservative 2013 EPS of $2.74, the rough intrinsic value of Kraft's stock is $46.58.
Consensus estimates for General Mills' EPS forecast that it will grow by 2.4% to $2.54 in 2012 and then by 9.4% and 8.3% in the following two years. Assuming a multiple of 17x and a conservative 2013 EPS of $2.73, the rough intrinsic value of the stock is $46.41, implying 19.5% upside. Recent quarterly performance was weak with EPS of $0.76 being 3.8% below consensus. Volumes fell domestically as the outlook weakened. Even Yoplait sales (a main catalyst) fell 6% in the second quarter. Going forward, management will shift the attention toward international expansion.
Kellogg, on the other hand, has delivered strong recent performance despite challenging circumstances. Fourth-quarter growth was 6% - exceeding long-term targets. Brand appeal is further improving, as demonstrated by the fact that the company is gaining market share across much of its product categories. Supply chain difficulties may have limited value creation in the recent past, but I am optimistic that launching new products, like Krave, in different markets will make the story brighter.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.