Mondelez's Price Hike Scared Customers And Profits


Mondelez’s last quarter was a reflection of poor choices as higher prices caused volumes to decline and scared off retailers.

Bottom line savings do not remove the fact that the top line is deteriorating and has been soft since the separation of Kraft.

The spinoff of the coffee business will generate savings but remove a major revenue generator from Mondelez’s portfolio.

The sluggish top line, inadequate measures, and poor decisions justify a sell rating for the company.

Mondelez International's (NASDAQ:MDLZ) product portfolio has several well-known brands. Some of them, which include the world famous Oreo and Cadbury brands, produce over $1 billion in revenue per annum. Perhaps when so much is at stake any pricing or marketing strategy must be thought through carefully before execution. However, it appears as though Mondelez didn't think through its recent strategy. The company, which has generated a 12% price return for investors during the past year, is now struggling to push sales.

The price hike it introduced has gone so badly that some stores in France decided to stop carrying Mondelez's products. In this article I will review the latest quarterly performance and highlight the impact of management's strategy. We will later discuss the future potential of this chocolate manufacturer.

Second Quarter

In its latest quarterly period, Mondelez saw its revenue fall 180 bps to $8.4 billion from the figure reported last year. The company experienced a 240 bps decline coming from less volume and a 360 bps increase coming from higher pricing. Of course, this pricing has taken a toll on volumes sold because the European region was precisely tough to operate in as a result of these price hikes. The rest was currency headwinds as 80% of the company's sales were international. The company had high hopes in the emerging markets and organic revenues rose 470 bps whereas the developed regions' revenues shrunk.

Mondelez has been reporting soft sales figures ever since it separated from Kraft (KRFT) back in 2012. Uneven emerging market conditions, issues owing to lower coffee prices, and slower worldwide segment growth have been weighing on the company's top line. Add to this the misery of higher prices, and the company has a recipe for disaster.

The adjusted gross margin declined 90 bps to 36.9%. This was a result of commodity cost inflation surpassing Mondelez's efforts to raise prices and create supply chain efficiencies. The year 2014 has brought about a sharp rise in input inflation especially for items such as cocoa and dairy used in the company's top brands.

Adjusted operating income increased 11.8% to nearly $2 billion on a currency neutral basis. This was gained through lower advertising costs, overhead cost cuts, and productivity gains which caused the operating margin to expand 120 bps.

The net result was adjusted EPS growing 19.4% to 40 cents on a constant currency basis driven by operating gains, lower interest expense, and share repurchases. As I said above, input inflation has been a major problem for Mondelez and it has been trying to console investors by enacting cost-cutting measures. The problem has been magnified by weakening currencies in several emerging markets.

Nearly half of the input cost increases were caused by currency fluctuations. This has forced the company to significantly increase prices, especially in chocolate products. Mondelez thought that the action would be somewhat disruptive in the short run but did not anticipate the response it has received. The company forgot that competitors have been careful and slow to implement price increases in what are Mondelez's chief operating markets.

The company is on track to spinning off its coffee business by next year which should generate bottom line savings of $1.5 billion by 2018. Though the move is supposed to be a good step, I believe that removing a business that generated nearly $4 billion in sales last year should be kept in a portfolio and optimized for extracting profits. Mondelez's top line has been struggling and removing a profitable business will only make things worse.

There is a sense of falling confidence in the management's ability to generate suitable returns for investors. In the past, Mondelez's net margin, return on equity, and other similar measures were below the industry level. This means that while the industry may be struggling, certain micro measures are causing only Mondelez's profits to fall.

As a result of these events, Mondelez has lowered its 2014 top-line growth target. The organic top line is now expected to be in the range of 2-2.5%, which is lower than the prior expectations of nearly 3%. Improving coffee prices and a favourable environment in China should benefit the top line in the coming period. Management says that it expects the tough retail and consumer atmosphere to continue. The company remains a risky venture based on these prospects. Therefore, I recommend selling the stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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