Post-Spin-Off Kraft: Investors Pursue Dividends Over Growth

| About: The Kraft (KHC)
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The former Kraft Foods Inc. (KFT) was in the headlines back in August when Warren Buffett revealed a substantial reduction in his position. However, Buffett still has a substantial position with 59 million shares. KFT is also making headlines due to the spin-off of its North American grocery business. On August 4, 2011, Kraft Foods announced the spin-off, which was formally approved this past August. That spin-off was completed this past week with the formation of the Grocery business as Kraft Foods Group Inc. (KRFT) representing the North American grocery business of Kraft Foods and Mondelēz International Inc. (NASDAQ:MDLZ) which contains the other international food and snack businesses. The following table shows KFT in comparison to several other U.S. based diversified food companies.

Select Food Stocks

Ticker Name Price Market Capitalization Forward Dividend Yield
GIS General Mills, Inc. 40.05 25.8 3.3%
K Kellogg Company 51.95 18.6 3.4%
CPB Campbell Soup Company 35.32 11.2 3.3%
CAG ConAgra Foods, Inc. 27.79 11.3 3.6%
KRFT Kraft Foods Group Inc. 47.57 28.2 4.5%
MDLZ Mondelez International 27.81 49.4 TBD

Source: Yahoo!Finance, Barrons, Author estimates and calculations

All of these companies have a similar forward dividend yield, which is more attractive than the broader market. However, the historical dividend raises are bit more of mixed bag. The former Kraft had not increased its dividend in a while and CPB has been at a quarterly dividend of $0.29 for about two years now.

Select Food Company Performance

Ticker Since March 29, 2011 Since August 14, 2012 Since August 4, 2011
KFT* 39% 2% 27%
GIS 15% 4% 15%
K 1% 3% 3%
CPB 12% 2% 14%
CAG 24% 13% 20%
SPY 14% 4% 25%

Source: Yahoo!Finance, Author calculations, Reflects performance to September 28, 2012. MDLZ is down slightly for last week, while KRFT is up approximately 5% for the last week.

The above table shows that not only has KFT outperformed the market since I last reviewed the company, but it has also outperformed its peers. This outperformance has been consistent since the announcement of the spin-off separating the North American Grocery business from the rest of the company. The following table compares the price to book ratios for these companies.

Price to Book Multiples

Ticker At March 29, 2011 September 28, 2012
KFT 1.5 2.0
GIS 3.8 3.9
K 9.1 8.6
CPB 12.6 12.2
CAG 2.1 2.4

Source: Yahoo!Finance, Author calculations

After the spin-off

The interesting question is now how will the two new companies will perform. The detailed split is described in the recent 10-Q:

Mondelēz will primarily consist of our current Kraft Foods Europe and Developing Markets segments as well as our North American snack and confectionery businesses and related categories in our Canada & N.A. Foodservice segment. Our subsidiary, Kraft Foods Group, Inc. ("Kraft Foods Group") will hold the North American Grocery Business, which will primarily consist of our current U.S. Beverages, U.S. Cheese, U.S. Convenient Meals and U.S. Grocery segments, grocery-related categories in our Canada & N.A. Foodservice segment as well as the Planters and Corn Nuts brands and businesses.

KRFT shares would be distributed via a dividend to former Kraft Food shareholders. Additional information on the spin-off is available here and here. The segments would be approximately redistributed as follows:

Segment Assignments

Old Division New Assigned Ticker
U.S. Beverages KRFT
U.S. Cheese KRFT
U.S. Convenient Meals KRFT
U.S. Grocery KRFT
U.S. Snacks MDLZ
Canada & N.A. Foodservice* KRFT
Kraft Foods Europe MDLZ
Kraft Foods Developing Markets MDLZ

Source: SEC Filings, *Would be split between MDLZ and KRFT based on smaller divisions.

Applying the above mix to the recent 10-k filings shows the following picture for 2009 to 2011.

Source: SEC Filings, Author calculations *select line items are not allocated to specific segments and cannot be allocated yet to KRFT or MDLZ. This results in the Total KFT margin to be lower than the average of the two new companies.

The higher growth MDLZ might be better compared to PepsiCo Inc. (NYSE:PEP) for snacks, while KRFT keeps the current peer group. KRFT also has higher margins. However, the key aspect will be at what price and associated valuation each share trades.

Allocating the unassigned costs to MDLZ and KRFT provides an indication of a full year of operating income of approximately $3.1 billion for KRFT and $4.0 billion for MDLZ. As a multiple this indicates, KRFT trades at 9.0x operating income and MDLZ is at 12.4x. Note that a operating income multiple would be lower than a net income multiple since it still has not been reduced for interest expense and taxes. In comparison, the 9.0x ratio lines up at the lower end of its peers based on estimated 2012 operating income with K at about 9.1x and CPB at 11.4x.

Potential for Growth and Dividend Investors

Looking forward, one would have to evaluate both companies individually. These financials suggest that growth investors might prefer MDLZ, while dividend investors would favor KRFT. Furthermore, with a ratio of 12.4x to operating income, MDLZ investors clearly anticipate superior growth to the other companies. MDLZ has also delivered vastly superior historical growth to KRFT. Given the low price to book value of the former Kraft Foods, there is potential for continued combined gains between the two companies. However, these first few days of October seem to suggest investors are more interested in the potential dividends from KRFT, which is up for the last week, while MDLZ is essentially flat.

Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.