Kraft Foods And ConAgra Are Good Long-Term Buys

Includes: CAG, MDLZ
by: Insider Monkey

Kraft Foods Inc (KFT) is the most popular stock in the Food Products industry among hedge funds tracked by us. At the end of last year, there were 38 hedge funds reported owning Kraft in its 13F portfolios. In total, they had nearly $6 billion invested in this $68 billion market cap stock. Among them, Warren Buffett's Berkshire Hathaway had the largest position in Kraft. The fund reported owning nearly $3.3 billion worth of the Kraft shares as of December 31, 2011. Bill Ackman's Pershing Square also had almost $800 million invested in this stock. Some other famous hedge fund managers who are bullish about Kraft include Nelson Peltz, Boykin Curry and Patrick McCormack. In this article, we are going to take a closer look at Kraft and decide whether investors should follow these hedge funds to add the stock to their own portfolios.

In August 2011, Kraft announced that it plans to be separated into two independent public companies: a rapidly expanding global snacks business, which would also include powdered drinks and coffee, and a North American grocery business, which would be spun off to the shareholders of Kraft. The company expects the split to occur before the end of 2012. A spinoff usually attracts many event-driven hedge funds because it will unlock some share value. This explains why there are nearly 40 hedge funds bullish about Kraft. We are also favorable about the split up of Kraft and we think its snacks business has stronger long-term growth potential.

One of the potential risks of investing in Kraft is less optimistic expectations of its planned spinoff. It seems that the market is also cautious about the implementation and results of its business separation. Kraft is currently trading at $38.31 per share and the company made $2.29 per share in 2011. So its current P/E ratio is about 16.7, a discount to the industry average of 20.71. In 2012, Kraft is expected to earn $2.52 per share. Therefore, its forward P/E ratio is about 15.2, also a small discount to the 16.57 of its peers. In 2013, Kraft is expected to make $2.78 per share, so its P/E ratio for 2013 is about 13.8. Over the longer term, the company's earnings are expected to grow at an average of 8% per year.

In the first quarter of 2010, Kraft bought Cadbury for about $18.5 billion of cash and stock. The acquisition is expected to provide large cost synergies for Kraft this year. In February 2012, Kraft said that it expects to reach around $800 million in cost synergies at the end of 2012, which exceeds the original target of the company and is one year ahead of the schedule. Kraft also mentioned that it had already generated about $400 million in revenue synergies from the acquisition with Cadbury and was on track to its goal of $1 billion revenue synergies. Overall we have a favorable view of the acquisition. We believe it will enable Kraft to increase its presence in the international markets and boost its growth.

Currently Kraft has a decent dividend yield of 3.03% and its payout ratio is about 58%. Though the low payout ratio implies that Kraft still has the potential to increase its dividends, we do not think it is likely to happen. Kraft's dividends are mainly contributed by its North American grocery business, which will be spun off to the shareholders. According to Kraft, its North American Grocery business will mainly focus on capital efficiency and dividend payout, while its global snacks business will mainly focus on growth. Without the global snacks business, the North American grocery business and its dividends will have little growth prospects.

A few major competitors of Kraft include ConAgra Foods (NYSE:CAG) and Ralcorp Holdings Inc (RAH). ConAgra is currently trading at $26.43 per share and it is expected to earn $1.96 per share in 2013. So its P/E ratio for 2013 is about 13.5, similar to the 13.8 for Kraft. ConAgra planned to acquire Ralcorp, but Ralcorp said in August last year that its directors had unanimously rejected ConAgra's proposal to buy Ralcorp for $94 per share as the proposal was not in the best interests of Ralcorp and its shareholders. The market in general does not think the merger is going to happen as Ralcorp is currently trading at $74.48 per share, a significant discount to the offer price of $94. But there are still a certain number of investors who are favorable about the acquisition. Ralcorp is expected to make $3.88 per share in 2012, and $4.12 per share in 2013, so its forward P/E ratio is 19.2 and its P/E ratio for 2013 is 18, both higher than the industry average. We do not think the acquisition is happening so we do not recommend investors purchase Ralcorp at this moment. On the other hand, we like Kraft and ConAgra. Though Kraft may not be a perfect stock for dividend lovers, we believe its planned spinoff will unlock some value and its acquisition with Cadbury will continue to bring incremental synergies and improve its margins.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.