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Summary

For income focused investors, the new spin-off Kraft Foods Group (NASDAQ:KRFT) offers an attractive, and likely sustainable, dividend yield. Though the yield is high, the payout, which I estimate at $2.00 per year, is justified by historic earnings and cash flow. The company's portfolio of brands is not the most glamorous but many are household names with dominant share in their categories.

Context

Old Kraft is now split in two, the bulk of the business is now named Mondelez (NASDAQ:MDLZ) and the U.S. retail grocery foods business has been spun off under name Kraft Foods Group and the ticker KRFT, which is the focus of this article. The old Kraft has outperformed the S&P 500 in the run up to the spin-off.

Old Kraft vs. S&P 500

May-Sept 2012

^INX Chart
(Click to enlarge)

^INX data by YCharts

A Confusing Spin-Off

This spin-off is particularly confusing because the Kraft corporate name is going with the relatively small spin-off, whereas the bulk of the assets and brand are being renamed Mondelez.

A 4.4% Dividend

It appears Kraft will pay a large dividend. The yield should be 4.4% (working off a $45 price) based on the information statement the company has filed. This is large enough that income investors may want to take notice.

Here is the source on the dividend, note that because KRFT's share count is now smaller a $0.64 dividend translates to $2.00 ($1.2 billion over 595 million fully diluted shares):

We anticipate paying a highly competitive dividend. We currently expect that the equivalent of $0.64 of the existing $1.16 annual dividend per share paid by Kraft ParentCo would be attributable to us.

and more directly from their investor roadshow presentation

We expect to recommend an annual dividend of $2.00 per share

But Is The Dividend Sustainable?

It's tight, but most likely yes. For the past 5 years, on average, on a pro forma basis, Kraft's net income and free cash flow have averaged $1.7B and $1.8B respectively based on the information statement, whereas the total cost of the dividend is $1.2B. That implies a 61-65% payout ratio - aggressive but potentially sustainable given the stable nature of the business.

The Kraft Brand Portfolio

Below shows the portfolio's portfolio of brands, with Oscar Mayer, Kraft cheeses and Maxwell House being some of the larger brands in terms of sales.


(Click to enlarge)

source: Kraft investor presentation

Other Ratios For the New Company

For reference, here are the other metrics I calculate for the new company. The dividend yield is the company's most attractive aspect, but the P/E is not particularly expensive.

Note: based on author's calculations and a price of $45.42

Ratio Value
Price to Earnings 18.9x (pro-forma 2011)
Dividend Yield 4.4% (assuming $2.00/share payout)
Price to Book 2.5x (pro forma book value of $10.958B)

source: company's information statement

Key Risks

  • Virtually all the calculations in this analysis are derived from my analysis of the pro forma numbers. There is a risk my assumptions underlying the pro forma analysis prove to be incorrect.
  • Though many of the company's brands are strong such as Oscar Mayer meats, Kraft cheeses and Maxwell House coffees the company also has many second tier brands, the three brands I just named each have over $1B in sales, but the company did $19B in revenues in 2011 and therefore houses many second tier brands.
  • In US grocery retail, without significant product innovation, growth is unlikely to exceed US population growth especially since core categories such as meat, cheese and coffee are unlikely to deliver above market growth rates
  • 24% of revenues come from Wal-Mart, this is a fact of life in US retail but not necessarily a pleasant one, and though volumes to Wal-Mart may expand, margins are unlikely to. And, of course, the volumes may come at the expense of other higher margin retailers that the company serves.

Conclusion

For income investors Kraft may prove an interesting idea. The dividend is attractive and sufficiently covered and. In addition, such a high dividend enforces capital discipline on management. The main risks are the caliber of the brand portfolio and the relatively unattractive state of US grocery retail as Wal-Mart grows share.

Recommendation

Income investors may want to keep the stock on their watch list particularly if, in the next few weeks, it proves to be the ugly duckling of the two shares that investors in legacy Kraft receive as can often happen after spin-offs.

Source: Kraft Offers Tempting 4.4% Yield