Buy Kraft Foods To Benefit From The Spin-Off

Recently, Kraft Foods (KFT) cut its 2013 guidance as the company is spinning off its North American grocery business in October, which will lead to the formation of two separate public companies -- Mondelez International and Kraft Food Group. The spin-off, which we discussed in detail in a previous article, is positive news and is expected to create value for shareholders. KFT will focus on the grocery market; this market is slow growing as compared to the snack food market, which will be under Mondelez International. Kraft Foods has growth potential and offers an attractive dividend yield of 2.9%. We recommend a hold position on this stock.

In the first week of September, the company gave its earnings guidance for fiscal year 2013, which was below the consensus; the stock was down ~5% on the news. The combined earnings for the two companies are expected to be in a range of $2.65-$2.7 for 2013, vs. a consensus of ~$2.8. Mondelez International is expected to earn $1.5-$1.55 per share for 2013, ~10% less than the consensus; long-term revenue is expected to grow by 5%-7%. The earnings for next year are expected to be low due to foreign exchange movement (strong dollar), restructuring charges, and higher overhead costs associated with running the companies. These factors are expected to affect only short-term earnings estimates.

The longer-term outlook given by management was in line with the consensus estimates. EPS is expected to grow to double digits for Mondelez International and high single digits for Kraft Food Group in the long term. The company has plans to allocate its resources to develop new products and target new markets. KFT is expected to pay an annual dividend of $2 in 2013, above the consensus of $1.92. Kraft Foods currently has an operating cash flow yield of ~7.7%, free cash flow yield of ~4%, and dividend yield of 2.9%. The company has a long-term free cash flow target of ~85% of net income, but it is expected to miss on its target for 2013 due to excessive tax payments of $200 million. Kraft is committed to cutting down on its costs by different means, such as reducing the size of its corporate office.

Kraft Foods signed a deal with National Investment Co. to acquire a 100% interest in Bimo. Kraft will pay $151 million for the full control of the company; it currently has a 50% stake. The deal is expected to be completed in six months and needs to be approved by regulatory authorities. Bimo is currently facing increasing competition in the Morocco's cookies market; more competitors are joining the market given its high growth. Bimo currently has a market share of ~13%.

Recently, prior to the spin-off, Fitch upgraded its credit rating for Kraft Foods. The credit rating has been upgraded from BBB- to BBB for longer-term issues, senior unsecured debt, and credit facility. The short-term issuer rating was also upgraded from F3 to F2. A stable outlook was maintained for the company by Fitch. This will give Kraft's creditors some confidence, reduce its borrowing cost, and have a positive impact on the company's bottom line. Currently, Kraft Foods has total debt-to-equity ratio of 84%, which is on the higher side as compared to the industry average of 43%. However, it has strong interest coverage of 3.4 times.






Gross Profit Margin






Source: Reuters.

Kraft Foods has maintained a decent gross profit margin over the years, despite the volatile input prices.



General Mills, Inc. (NYSE:GIS)

Kellogg Company (NYSE:K)

Pepsico, Inc. (NYSE:PEP)

P/E Forward










Source: Yahoo Finance.

Kraft Foods' forward P/E is supported by its high growth of ~11% per annum for the next five years. Its PEG of 1.5 reflects that the stock is attractive and offers cheap growth as compared to its competitors. The spin-off will allow the two businesses to grow and increase shareholders' returns by unlocking its hidden value.

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

Business relationship disclosure: The article has been written by Qineqt's Consumer Staples Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.

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