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Should You Follow Peltz's Move on Mondelez?
Posted by: Fede Zaldua (IP Logged)
Date: October 30, 2013 05:19PM

Activist investor Nelson Peltz is now pushing Mondelez (MDLZ), the snack business that was previously part of Kraft Foods (KRFT), to increase efficiency through cutting costs. The investor says that the company should be able to significantly increase its operating margins to 18% from the currently low 12%.

According to Peltz, who is the founder of Trian Fund Management, Mondelez could double its earnings per share (EPS) just by cutting costs aggressively the way other consumer goods companies such as AB-InBev (BUD) have done in the past. If Peltz's claims are heard by the company's management and if Mondelez's inefficiencies are as great as the investor says they are, maybe you should consider the snacks giant as a long term bet. Let's take a look!

Expenses Are Indeed Too High

Mondelez's 12% profit margins are indeed among the lowest in its industry. For example, Nestle (NSRGY), has operating margins that are as high as 15.4% while Unilever (UN)'s operating margins are at 13.8%. As a percentage of sales, Mondelez's SG&A costs are 25%, which is higher than those at other packaged-foods peers such as the recently acquired (by private equity firm 3G and Berkshire Hathaway) Heinz. The margin gap seems to be there. Can the company actually close it? According to Mondelez's management, the answer is yes.

Plans to Expand Margins Are on the Way

Mondelez's management is clearly trying to defend itself against Trian, and they are doing so in a constructive way. Mondelez has established for itself very aggressive operating margin goals. The plan aims to expand operating margins by 5% in North America and by 2.5% in Europe. As a matter of fact, Daniel Myers, who is Mondelez's supply chain head, gave a compelling presentation explaining the investments the company aims to make in order to increase efficiency and cut labor costs.

Effective measures are already in place. Last month, the company said that during the next three years it would expand profit margins through $3 billion in production cost savings; $3 billion represents more than 8% of total annual sales. For example, the company said that the new Oreo manufacturing lines would require 30% less capital.

That said, and despite management's efforts, the margin target the company has announced does look far too optimistic. I do not think the company shall be able to expand operating margins at such rocket-high speeds. Nevertheless, I do see improvements coming, and an overall margin of 14% do look plausible. According to Credit Suisse's estimates, if operating margins improve to 12.6% in 2014, 13.2% in 2015 and reach 13.7% in 2015, EPS would grow at a 12% year-over-year pace.

Bottom Line

An investment in Modelez does look compelling even when management's target looks too good to be true. If managers are able to achieve just half their margin targets, you will get a company growing its EPS at a 12% year-over-year pace. It's true that the company trades at 19 times 2014 earnings against Nestle's 18 times multiple, but higher future growth deserves a premium.


Stocks Discussed: MDLZ, KRFT, BUD, NSRGY, UN,
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