Mondelez and Kraft Still Face Big Challenges

by Dan Burrows | October 2, 2012 1:59 pm

On the face of things, the breakup of what used to be Kraft into two companies makes a lot of strategic sense — but that doesn’t mean either stock is a buy just yet.

The former Dow component officially turned into two separate companies[1] Tuesday. Mondelez (NASDAQ:MDLZ[2]) is the high-growth snacks company — the world’s biggest maker of chocolates, candies and cookies, encompassing brands like Oreo, Cadbury and Nabisco.

The other company, known as Kraft Food Group (NASDAQ:KRFT[3]), is the slow-growth dividend payer, comprised of the North American grocery business. Boring but seemingly stable, its portfolio of brands includes such staples as Velveeta, Miracle Whip and Oscar Mayer meat products.

Mondelez is expected to enjoy double-digit earnings growth from operations (that is, excluding special items, as analysts usually do). Kraft will plod along with mid- to high-single-digit earnings growth, but throw off a healthy dividend. Indeed, it currently yields about 4.5%.

Unshackling the slow-growth dividend payer from the international snack business is a defensible and probably wise move. But both companies face the same hurdles they did before the split.

About a third of Mondelez’s revenue comes from Europe, for one thing, and both the eurozone and the 27-country European Union are in a recession that shows no signs of abating anytime soon.

Furthermore, all that international exposure has Mondelez facing currency headwinds. A strong dollar not only makes its products more expensive overseas, but revenue also takes a hit when relatively cheap euros are exchanged back into comparatively stronger U.S. dollars.

Heck, the company issued a warning last month that the Street’s 2013 earnings forecast for Mondelez might be too high because of the dollar’s continuing strength.

And Mondelez, just like Kraft Food Group in North America, still faces increasingly stiff competition from generic and store brands.

When times are good, consumers pay a premium for well-known brands. But when times are tough, cash-strapped customers look to save every penny, making generics, store brands — and margin-compressing discounts and sales — the order of the day.

At the same time, Mondelez and Kraft are both facing higher input costs, as droughts and central bank easing conspire to push up costs for commodities. If the companies can’t pass those costs on to consumers in the form of higher prices — a huge if — margins will suffer. And even if they do manage to raise prices, well, then you have to worry about a drop-off in volumes.

But the biggest reason to hold off on initiating a position in either Mondelez or Kraft is that there’s no harm in waiting to see how these businesses fare, post-split. Separating the snacks business from the grocery operations might have solved one big problem — but plenty of other challenges remain.

As of this writing, Dan Burrows held no positions in any of the aforementioned securities.

  1. turned into two separate companies:
  2. MDLZ:
  3. KRFT:

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