Kraft-y Investing in a Turnaround

Kraft Foods (KFT) reported an unexpected jump in profits earlier this week as its commodities hedges and price hikes made up for the rising costs of raw materials. The world’s second largest food producer ended up turning a profit of 4% during the second quarter (see conference call transcript), which has added credibility to its three-year turnaround plan.

Kraft Foods also has many strong believers, including billionaire Warren Buffett. The Oracle of Omaha first disclosed a position at the end of 2007 and has since boosted it to 138.3 million shares. Buffett believes that the company has a strong brand portfolio, generates consistent free cash flows, and is substantially undervalued.

Recently, Kraft Foods has struggled with a sharp increase in the cost of raw materials that it uses to manufacture its foods, such as cocoa and wheat. Such a rise put Kraft in a difficult position – it could either take a hit on its profit margins or raise prices and risk losing customers. The company decided to raise prices and the strategy seems to have worked.

Strong financial performance this quarter combined with such confident backing from the world’s great investor makes Kraft Foods a stock worth considering for any investment portfolio. After all, it is a strong brand that isn’t going to die anytime soon, the world’s greatest investor is backing it, and shares are trading right near their 52-week lows.

One great way to purchase shares of Kraft Foods is to purchase LEAPS – or long-term equity anticipation securities. These are essentially long-term stock options that have expiration dates set two years or more into the future. For many investors, they offer a way to leverage money without taking on as much risk as a margin account.

Currently, the 25 January ’10 LEAPS are trading at around $7 per contract. This means that investors can purchase the right to 100 shares of Kraft Foods stock for just $700 right now instead of paying $3,083 for the full 100 shares. The premium, however, means that the stock must rise above $32 per share before it is worth money.

Given the turnaround potential at Kraft Foods a $32 per share price over the next two years doesn’t seem that unlikely. It is also important to remember that you can exercise or sell the options at anytime before expiration. The less than $2 premium over the market price also makes these rights very cheap by any measure.

In the end, investors who are looking for a cheap way to mimic Warren Buffett’s Kraft Foods trade may want to consider purchasing LEAPS while they are at such cheap levels. The symbol for the LEAPS discussed in this article is YTWAE.

Also see: Using LEAPS as a Stock Substitute

Disclosure: none