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For reasons that don't make a lot of sense to me, investors continue to reward a host of under-performing food companies with pretty robust multiples. I understand the value of a good brand, and I don't fault investors for hanging on to Coca-Cola (NYSE:KO) or PepsiCo (NYSE:PEP) even though neither are cheap, but I wonder why so many investors are happy to pay premiums to hold companies experiencing uncontrollable cost inflation and increasing elasticity from consumers.

Amidst that gloomy backdrop, Kraft (KFT) stands out in many respects. Kraft has very strong brands and has actually managed to show less price sensitivity than other North American comps. And while these shares aren't a raging bargain, they look like the cheapest idea in large-cap North American food.

Another Solid Quarter

Kraft's first quarter saw revenue rise 4% as reported, and more than 6% on an organic basis. Although the timing of the Easter holiday chipped in a meaningful benefit, price growth of 5.5% and volume growth of 1% were solid numbers. North America was soft (up 3% organic) on weaker volume, but Europe was surprisingly strong (up 7% organic), and developing markets are growing nicely.

Margins are a little convoluted because of Kraft's neverending restructuring. Gross margin slid more than a point as the company continues to absorb higher costs across the spectrum of its inputs. Operating income rose about 3% as reported, or nearly 6% on an adjusted basis, with North American results lagging a bit.

Nielsen Data And Price Sensitivity Speak Well To Kraft's Brands

It doesn't really matter if you look at Kellogg (NYSE:K), General Mills (NYSE:GIS), Campbell Soup (NYSE:CPB), Nestle (OTCPK:NSRGY), or any other packaged food manufacturer - pretty much everybody is seeing market share pressure from customers switching to private labels.

Well, pretty much everybody except Kraft. I don't mean to suggest that Kraft has been immune to the private label trend, nor that the company is gaining share everywhere, but the company has been holding up well in most of its key categories.

It's also interesting to compare the price/volume trade-offs among major North American food companies. Kellogg ends up looking best, but the year-on-year comparisons are not quite apples-to-apples because of disruptions in the year-ago period. Adjust that out, and Kraft is showing the least sensitivity of the major players.

Pondering A Post-Split Kraft

Investors certainly aren't going to forget that Kraft is about to split into two new companies - the grocery/staples-oriented "GroceryCo" and the horrifically badly named snack food business "Mondelez". With the company recently giving investors a bit more data, it's interesting to speculate on what sort of business GroceryCo will be post-split.

For starters, the company's margins aren't all that good (below 15% operating margin and pointing in the wrong direction). What's more, the company has a relatively low ROIC that puts it between grocery staples General Mills and ConAgra (NYSE:CAG). Also worth noting, this segment doesn't spend as much on promotion as other grocery companies, so margins and returns may be in some sense inflated.

GroceryCo is probably going to emerge as a slow-growth company with very strong share and a pretty high dividend payout. I do wonder, though, if there may be some interest on management's part in swapping around assets.

For instance, I'm not sure Oscar Mayer offers the margins this company wants, and they may want to think about selling it to a company like Tyson (NYSE:TSN), Smithfield (NYSE:SFD), or Brasil Foods (NYSE:BRFS) - the first two could definitely use more packaged/branded exposure, and the latter has made no secret of wanting to acquire North American brands. On the flip side, proceeds could be used for dividends, debt repayment, or the acquisition of other brands (like, perhaps, Clorox's (NYSE:CLX) salad dressing business if that were to come up for sale).

The Bottom Line

While Kraft looks like the best risk-reward trade-off in North American food, that's not to say that it's startlingly cheap in its own right. I do believe that the company can grow cash flow at a mid single-digit rate (or higher) on a consolidated basis, but that's only good enough for about 15% undervaluation. For better or worse, if investors want to invest in food they have to choose between well-valued quality companies like Coca-Cola, PepsiCo, slightly cheap companies like Kraft, or more speculative stories like Brasil Foods.

Disclosure: I am long BRFS.