Should You Buy the Dow — Kraft Foods

by Lawrence Meyers | October 17, 2011 7:00 am

Logo2 Should You Buy the Dow    Kraft Foods[1]Today, we’re looking at Dow Jones Industrial Average component Kraft Foods (NYSE:KFT[2]). The company recently purchased Cadbury, best known for its chocolate, and is a snack-food powerhouse, but of course the company makes a lot more than just snacks.

Kraft makes beverages, including coffee, juice and powdered drinks; cheese products, dressings, condiments and desserts; and processed meat and packaged meals. You’ve unquestionably heard of its amazing brands, which include Oreo, Nabisco, the aforementioned Cadbury, Trident, Maxwell House, Philadelphia cream cheeses, Oscar Mayer and the inimitable Kraft Macaroni & Cheese. Through its massive distribution and retail network, the company sells its products to supermarket chains, wholesalers, supercenters, club stores, mass merchandisers, distributors, convenience stores, gasoline stations, drug stores, value stores and retail food stores. I defy you to enter any store selling snack food in the U.S. and not find a Kraft brand.

The key driving factors regarding Kraft are the economy and competition. The truth is that in a bad economy, snack foods don’t see as much action. People stick to necessities, and snacks are a treat. As for competition — hoo boy! Oreos are certainly not the only cookies out there. Cadbury isn’t the only chocolate. Trident isn’t … well, you get the idea. Add in the fact that grocery stores have launched private brands in many of these same categories and you can see why Kraft has wars going on many fronts.

Stock analysts looking out five years on Kraft see annualized earnings growth at 10%. At a stock price of $34, on FY 2011 earnings of $2.27, the stock presently trades at a P/E of 15.

Normally, this is where I’d get into the company financials, but Kraft is still in flux as the Cadbury buyout gets absorbed. No, the story of Kraft is really about the synergy between these two behemoths. I suggest reading over hedge fund manager Bill Ackman’s thesisĀ on the merger[3]. In essence, he expects cash flow and gross margin to increase significantly, and expects the company to benefit from massive cost cuts and from the improved business quality of the combined entity and a higher organic growth profile. He also believes that Kraft is worth between $43 and $52 (including 3.4% dividend) over the next year or so.

Conclusion

Ackman made his pitch in early 2010, when Kraft was at $28. He added to his position in the first quarter of the year, and holds more than 22 million shares, or about 1.3% of the company. Ackman has a great long-term track record. It appears there is some 30% or more upside from here, making it a reasonably attractive, but not quite conservative enough for retirement accounts.

As of this writing, Lawrence Meyers did not own a position in any of the aforementioned stocks. Check out Meyers’ take on other Dow Jones stocks here[4].


Endnotes:
  1. [Image]: http://investorplace.com/hot-topics/should-you-buy-the-dow/
  2. KFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=KFT
  3. Bill Ackman’s thesisĀ on the merger: http://www.marketfolly.com/2010/02/bill-ackman-pershing-squares-kraft.html
  4. here: http://investorplace.com/hot-topics/should-you-buy-the-dow/

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