Kraft For The Long Run

By Kersasp Shekhdar

The company behind that instantly-recognizable chocolate, Toblerone, Kraft Foods Inc. (KFT) occupies a lonely position in the United States - competitors are few and far between. Kraft competes with Sara Lee in packaged meats and frozen desserts and with Mars in all things chocolate. But both Sara Lee and Mars are privately owned so we do not have the financial data to make any comparisons with (and even if we did, you would not be able to trade their stock). Other major food sector companies, like Cargill and Archer Daniels Midland, are in the grains and raw foodstuffs business, rather than packaged foods. As for Kellogg and General Mills, which are sometimes mentioned as Kraft competitors, spot the self-contradiction in the following sentence from a Motley Fool report: "Kellogg (NYSE:K) and General Mills (NYSE:GIS) have struggled to grow and raise prices as their products are primarily tied to the breakfast market" unlike those of purported competitor Kraft!

However, at a market cap of $70.2 billion, Kraft can be compared to Unilever plc (NYSE:UL) at $97.5 billion in the U.S. market. Both are dwarfed by packaged food's giant Nestle (OTCPK:NSRGY), with a market cap of $193 billion, but a comparison is still possible. However, given that 'comparisons are odious', we'll also examine Kraft on its own merits.

The bad news first. What strikes me plumb between the eyes is the company's (operating) cash-flow-to-debt ratio. With operating cash flow of only $4.52 billion to cover total debt of $27.5 billion, the company finds itself uncomfortably positioned with a cash-flow-to-debt ratio of 0.164 - unusually low. Both Nestle and Unilever have much more liquidity (operating cash-flow-to-debt ratios of 0.432 and 0.4 respectively). And for a $70.2 billion company, Kraft keeps very little 'cash on hand' - just $2.06 billion. This is not to suggest weak fundamentals - Kraft is just rather more illiquid than most, a point borne out by its fairly attractive (current) debt-to-equity ratio of 0.88 which, together with the total cash figure and cash-flow-to-debt ratio further suggests the predominantly non-cash nature of Kraft's assets. This is borne out by the company's balance sheet, which reveals a significant investment in property, plant and equipment, along with a significantly revised figure for intangible assets, very possibly arising from a re-evaluation of its (truly) immensely strong product-line's name recognition, and their consumer trust levels.

The clue to these figures (i.e. cash-flow-to-debt ratio and cash on hand) about Kraft is found in another statistic when compared with the same two peers, but first a look at traditional price-to-earnings - P/E - ratios. Interestingly, P/E ratios, both forward and trailing, for all three companies, for a total of six, are plumb between that magic interval of 14 and 20. So nothing to go on here. It's the (forward) price/earnings-to-growth ratio - PEG ratio - that is the differentiator: Nestle's and Unilever's are 3.94 and 2.25 respectively but Kraft's is only 1.69. Not only is Kraft's PEG ratio small relative to its competitors, it is small for any capital-intensive industry, indicating growth prospects. This statistic leads to another: the company's eye-popping (year-on-year) quarterly earnings growth of 54%, which is even more eye-popping when compared with the industry average. Kraft's key statistics give the impression of, not a mature company (which, of course, it is), but a growth stock. And that explains and justifies the other figures examined earlier.

These facts and figures also go some way toward explaining Kraft's share price trajectory over the past one year during which its 'mountain' has jaggedly inched upward, rising from about $32 per share to nearly $40. Despite these gains, as of this month Trefis is still somewhat bullish on Kraft stock: "We currently estimate a $41.83 price for Kraft Foods, which is about 6% higher than the current market price." Let's see if Trefis's estimate has any validity.

Kraft Foods is not itself into high-profile branding but under the Kraft umberella it maintains a portfolio of best-in-breed brands: chances are you have Philadelphia Cream Cheese in the fridge, Oreos in the cookie jar or Maxwell House on the kitchen counter (not to mention its globally-famous brand of cheese). All three, alongwith an array of other household names, are Kraft brands. But Kraft's claim to fame, numbers-wise, is its 'slow and steady' approach which is glaringly obvious. Its dividends, though not spectacular, are self-evidently dependable and steady, quarter-in quarter-out with a solid, respectable 3.7% five-year average yield. And its total revenue over three years shows an inexorable rise. The hare and the tortoise, anyone? Bolstering my tortoise analogy is some of the phrasing Shine's Room uses in its May 2012 analyst report for Kraft: "sturdy sales growth, effective cost management and prudent investments."

Though the tortoise eventually wins the race, it is admittedly slow. Smartrend wrote in April 2010, "Kraft Foods has the Lowest EPS Growth in the Packaged Foods & Meats Industry," while also stating, "its PEG ratio is 1.86, which signifies a premium valuation given for growth." The negative outlook on EPS is counterbalanced by this factoid from ePerspective in November 2010, which corroborates my and Smartrends' opinions about Kraft's growth prospects: "Packaged food companies with higher exposure to emerging markets, such as Kraft Foods Inc. and H.J. Heinz Co., are likely to generate more robust sales and earnings growth in 2011 and over the long term." And so Trefis's estimate is probably fairly sound.

Conservatively, on a purely present-value (and not growth) basis, Kraft's stock may be overvalued relative to its major competitors. Perhaps it will either be subject to a relative correction or its competitors' stock prices will appreciate a little more in comparison to Kraft. However, stable packaged foods-company stocks do not lend themselves to share-price speculation and short-term gains. These kinds of stocks are better seen as long-term investments; one for the retirement portfolio. And Kraft, because of its steady growth prospects, is a prime choice. If you have any questions, start here at Kraft's website - this is a company that engages with its stockholders.

There's a bit more to Kraft and its growth plans than what the numbers and statistics reveal. Shine's Room's May 2012 analyst report states: "Kraft is all geared up to split its two independent public companies which are the highly regarded global snacks business and the extreme-margin North American grocery business. We believe that this spin-off will be finalized by the end of 2012;" a point brought up by Trefis in its May 2012 report: "Kraft . . . readies itself for the spin-off. The company will split into two companies i.e. the North American Grocery division and the Global Snacks division. It will rename the latter as Mondelez."

According to Motley Fool, "The split, which is expected to happen this year, should offer shareholders better returns as the slower-growth grocery line should cater to income-seeking investors while the snack division will cater to those looking for stronger growth opportunities in the food sector." But Shine's Room's analyst opinion is: "We believe that due to the spin off the strength of the company will be divided which could reverse its course." I concur. It's a very short term idea betraying "Wall Street au gogo" philosophy. Kraft has a good thing going and trying to split like an amoeba into two, one company geared for growth and the other for income, could create one anchorless, free-drifting company and another one becalmed in dead waters. Don't mess it up, (C.E.O.) Ms. Irene B. Rosenfeld. Else it could be 'Goodnight, Irene'!

Kraft - like all diversified packaged foods companies - is not vulnerable to market-sector cycles nor is it subject to the unpredictable vagaries of high-tech stocks. In fact, where diversified packaged foods companies are concerned, a growing population implies a greater consumer base, and societal trends toward packaged and precooked foods implies a greater demand for packaged foods companies' products. And among such companies, America's Democracy has one King: Kraft.

And so, to my round-up: This is not a stock you 'time' nor is it a company whose quarterly figures you obsess over. With respect to traditional stock ratings, I have my own twist on Shine's Room's 'Neutral' rating. Kraft is not a stock to 'buy' and it's not a stock to 'hold'. It is a share-certificate to keep - it's a 'keeper.' If you're young, then get a 'quick hit' by 'timing' a biotech stock to pay for your vacation (or get another kind of 'quick hit' by eating some Toblerone). But buy Kraft for the (very) long haul. And give your kids some Toblerone now to give them a 'taste' of the Kraft share certificates that will be coming their way through your will and last testament many years down the line.

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