As I have mentioned previously, I enjoy researching stocks; I would rather listen to a webcast of an analyst meeting than watch some reality television show. On most nights when I do research, I read the online annual report, listen to an analyst presentation and then decide I don't like what I have seen. However, on a recent night, I discovered a stock I really like, and it wasn't even the stock I was originally interested in looking at.
Kraft Foods Group
With the recent break-up of Kraft, I thought I would take a look at the new entity, Kraft Foods Group (KRFT). Kraft Foods Group is now a North American grocery business, selling packaged food products like cheese, meat, coffee, salad dressing, etc. Kraft Foods Group is the second largest food company in the world, and it owns some of the most well-known names on the grocery shelves, such as Jell-O, Oscar Meyer, Cool Whip, Maxwell House, Planters and others. The company is expected to be a cash rich, slow growing business that pays a generous dividend of over 4%. The most interesting statistic I heard while listening to the presentation was that you will find at least one of Kraft's products in 98% of U.S. households.
Despite the great name recognition and excellent share of store shelf space, Kraft Foods Group does have some issues. The grocery business is a highly competitive business -- gaining 1% share is a major victory. Commodity cost volatility is normal. Despite having hedges on the various commodities, the fluctuation in prices makes long-term planning difficult. Private label keeps making gains and grabbing market share as stores push their own branded products with higher margins over national products.
As a dividend growth investor, the expected dividend payout of over 4% is extremely interesting to me, and the statement by Chief Financial Officer Tim McLevish that "We put dollars in shareholders' pockets" highlighted to me the focus Kraft Foods Group will have on paying a generous and growing dividend. Management forecasts mid-to-high single digit earnings per share growth, and consistent mid-single-digit dividend growth.
During the presentation, McLevish stated that Kraft Foods Group will initially pay an annual dividend of $2.00 a share. So let's take a look at how that would look over five years. For the following chart, I used 5% (mid-single-digit) as the annual dividend increase, and showed no share price increase so you could get a sense of the increasing yield.
|Year||Share Price||Expected Dividend||Yield|
Using the above scenario, an investor buying 100 shares today at a cost of $4,722 would receive $1,360 in dividends over the approximate five-year period, which is slightly less than 29% of the purchase price.
After doing my research, I was attracted to the stock, seeing it as a relatively safe, slow growing business with great cash flow and an attractive dividend that would continue to grow. However, I had one problem: without any history of earnings and little guidance from management, what is a fair price to pay for KRFT? Even management admitted there was little earnings visibility, stating "we recognize that using our 2012 reported financials will make projecting future results difficult." So my question was, is paying today's price of $47.22 going to be 25 times earnings or 15 times earnings? In addition, management included a little warning that there could be a "potential headwind from required, spin-related pension revaluation." In other words, the company may have to take a charge for pension costs. It was at this point that I decided to place KRFT on my watch list so I could follow the price movement and better gauge the company after an earnings report or two.
Information concerning Kraft Food Groups can be found here.
Having completed my analysis of Kraft Foods Groups with time on my hands, I clicked on the Mondelez International (MDLZ) investor presentation that was right next to the Kraft Foods Group presentation. I did not have much interest in the company at the time because I knew from what I had read that Mondelez was going to pay a small dividend, and would not fit my disciplined plan of a company having to pay at least a 2% dividend for me to consider purchasing it. But I decided I would take a look anyway, and then I fell in love.
In CEO Irene Rosenfeld's words, she is "unleashing a global snacking powerhouse." Mondelez will sell cookies, gum, candy and chocolate to the world, and will look to become No. 1 or No. 2 in all snack categories, which it already is in most cases, as shown in the chart below:
Mondelez owns some of the best snack brand names in the world, including Oreo, Cadbury, Lu, Chips Ahoy, Halls, Trident, Ritz, and others. Sales of these brands are spread out among various geographies, with 44% coming from rapidly growing developing markets
Mondelez management sees mid- to high-teens growth coming from China, India, Russia and Brazil, as well as what they term "next wave" markets in the Middle East, Africa and Indonesia. Currently, 44% of the company's sales come from developing markets, and management sees this share growing.
Mondelez CFO David Brearton stated that he sees long-term, double-digit earnings per share growth on a constant currency basis. The majority of this earnings growth will come from developing markets, which will see strong double-digit growth, while developed markets like Europe and North America will add low- to mid-single digit growth.
The candy, gum, snack business is a high margin business and, as such, Mondelez will have excellent free cash flow. Management intends to use the cash to reinvest in the business for growth, and to tack on acquisitions, pay down debt and return capital to shareholders, mostly in share repurchases, while also paying a small dividend. The initial dividend will be $0.52, which is a yield of approximately 1.9%
Earnings for fiscal year 2013 were forecast to be $1.50 to $1.55 a share. Using today's price of $27.36 and using earnings of $1.52 a share (middle of projected earnings), Mondelez is selling for a price to earnings of approximately 18, which I think is dirt cheap for a company that has the growth in front of it that Mondelez has.
Why I Like Mondelez
Mondelez has a wide moat in most of the categories it competes in. In biscuits (cookies/crackers), it is the No. 1 brand in the world with an 18% share. The next closest, Kellogg (K), has a 4% share. In gum, there are essentially two competitors -- Mars, with a 32% share, and Mondelez, with a 30% share. The next closest competitor, Perfetti-Van Melle, has a 7% share. Trident, a Mondelez brand, is the No. 1 gum brand in the world. In the chocolate business, Mondelez is No. 1, ahead of Mars, Nestle (NSRGY.PK) and Hershey (HSY).
The candy, gum, and snack business is a high margin business with little generic competition. Consumers see snacks as a treat, thus they normally don't trade down. In other words, consumers want that special treat, not a cheap treat. In addition, snack foods is a sustainable business. Twenty years from now, people will still be eating candy and chewing gum.
Mondelez has a huge advantage over other competitors in that it already has a significant presence in leading emerging markets like China and India. Using brands like Lu and Cadbury that have been on the shelves in many developing markets for years, Mondelez can add products like gum and cookies to the supply chain. For example, in China, Mondelez has a strong biscuit business, with Oreo being the No. 1 cookie. Using the supply chain structure that is already in place, Mondelez will begin adding gum, candy, etc. to increase its product mix and boost sales. In India, Mondelez has a strong chocolate presence, and will use that strength to add cookies and beverages. A competitor without this "route to market" as Mondelez calls it, is at a disadvantage, as the cost to build a supply chain is extremely high.
As all well-run companies do, Mondelez has a growth plan, called "5-10-10," which is five categories, 10 markets and 10 power brands. Mondelez intends to focus on the leading categories and brands to leverage growth in the key growing markets throughout the world.
During the presentation, Mondelez management mentioned more than once that their long-term earnings per share target is double-digit growth on a constant currency basis. The chart below shows where the share price could be five years out, assuming minimum double-digit earnings per share growth of 10% and a constant P/E of 18.
|Fiscal Year||Earnings||P/E||Share Price|
As you can see in the chart above, assuming Mondelez achieves its target of double-digit earnings growth, an investor could see a gain of 62% over five years, not including the dividend. I freely admit there are a number of assumptions built into the chart, and any or all of those assumptions could be proven wrong. However, when trying to forecast where a stock may be headed, you have to use some assumptions, and Mondelez management sounded very confident that they can achieve long-term double-digit earnings per share growth.
I like to be a disciplined investor, and I have rigorous standards for determining if a stock should be bought. One of those standards is a yield of over 2%, which Mondelez does not meet. At a dividend rate of $0.52 a year, the yield currently is 1.9%. If the stock price were to fall into the $26.00 range, the yield would hit 2%. In this case, I am willing to accept the slightly less than 2% yield because I believe Mondelez will have significant free cash flow, which will be used in part to consistently grow the dividend. I like to think long term, and I assume for the next five years, management will be focused on growth and will be buying back shares so they can increase the earnings per share growth. However, at some point, growth slows down and additional cash is moved to the dividend. Would I like a bigger dividend? Yes. However, the opportunity to buy a growth stock in its infancy with significant free cash flow is too good to pass up. In addition, I believe that as the company matures, the larger dividend will come.
I intend to take a full position in Mondelez very soon. Right now, I am watching the price action to get a sense of where I might be able to pick it up for a fair price. Mondelez started trading on October 2, opening at $28.42 a share. Since then, it has stayed in a tight range between $27.00 and $28.00. I believe at some point, it will break out of that range, hopefully lower. Then I will get a good entry point, and maybe my 2% yield.
Information concerning Mondelez International can be found here.
Disclosure: I have no positions in any stocks mentioned, but I may initiate a position in MDLZ in the next 72 hours.