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Should I Buy Kraft? 3 Pros, 3 Cons

The company's Q4 sales were downright ugly

   

Kraft (NASDAQ:KRFT) CEO Anthony Vernon did not mince words the company’s recently reported fourth-quarter results. He noted that there was “some significant disappointment” … especially with revenue. Sales fell by double-digits to $4.49 billion, while the Street was looking for $4.74 billion.

Adjusted earnings did come in at a healthy 57 cents a share at least, which was well above the consensus estimate of 23 cents a share.

And the good news is that it looks like the revenue short-fall seems to be a temporary issue. In Q4, Kraft had to deal with some overhang from inventories, in part due to the complex process of being spun-off from the parent company Mondelez International (NASDAQ:MDLZ), which holds the global snacks business. Kraft, on the other hand, is focused on the grocery business in North America.

So going forward, will the company pick up momentum? To see, let’s take a look at the pros and cons:

Pros

Consumer Foods Powerhouse. When it comes to the North American market, Kraft has tremendous scale, with about $18 billion in revenues. The company’s brands include iconic names like Oscar Mayer, Velveeta, Stove Top, Philadelphia, Maxwell House and Miracle Whip. Consider that nearly ten brands have over $500 million in revenues and 29 have over $100 million. In fact, the household penetration in the U.S. is 98% and 99% in Canada.

Innovation. This has been a big problem for Kraft. Back in 2008, for example, 17 of 19 new product launches were failures. But then again, the company generally had little focus on promoting innovation and did not invest heavily in new products. Now, though, this approach is changing in a big way. That is, Kraft has instituted a company-wide program to encourage more creativity and to invest more in R&D and marketing. Another key has been to focus resources on fewer new products and, already, Kraft is seeing results. Over the last three years, the company has launched successful products like MiO, Oscar Mayer Selects and Velveeta Cheesy Skillets. All have hit over $100 million in revenues.

Finances. While Kraft inherited $10 billion in long-term debt from the spin-off, the company has enough cash flows to handle the payments. The company is also trying to lower its cost structure. Some of the moves include productivity programs, improvements in the supply chain, initiatives to lower the cost of good sold and better incentive compensation (especially by offering more equity to employees). Kraft also has an attractive dividend, which is currently at 4.2%.

Cons

Growth Limits. By being focused only on North America, Kraft will have a tough time finding new ways to generate more revenues. While it has had some success with its innovation program, it is still in the early stages and is far from guaranteed. The consumer foods industry is, once again, notorious for failed launches. The North American market also remains sluggish. In other words, consumers continue to look for cheaper alternatives, such as private-label brands.

Leverage. Kraft’s retail distribution is becoming challenging. Because of consolidation, there are only a handful of retailers to sell to and this means they will likely have more power to negotiate better terms. Keep in mind that five customers account for 41% of Kraft’s overall sales. The largest one is Walmart (NYSE:WMT), which represents a whopping 24%.

Competition. Kraft’s industry includes many large competitors such as General Mills (NYSE:GIS), Nestle (PINK:NSRGY) and Unilever (NYSE:UL). Many have global operations and huge amounts of resources to invest in product development and acquisitions.

Verdict

Kraft is certainly a world-class company with top brands and a tremendous distribution footprint in North America. It is also encouraging that the company is investing in innovation, as this will be crucial for long-term success.

But again, these efforts will not be easy. Kraft is experimenting with different approaches and there will inevitably still be failures. Besides, the North American market is highly competitive and involves a concentrated number of buyers for its products, which will make it tougher to increase prices.

Given these factors, it could be a fairly mediocre year for Kraft. For now, it looks like the cons outweigh the pros.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of “How to Create the Next Facebook” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders.”Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/02/should-i-buy-kraft-3-pros-3-cons-2/.

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