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Kraft Foods: Looks Attractive on Correction

June 06, 2014 | About:

Value Investor

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Kraft Foods Group (KRFT) is a food and beverage company, formed after the spin-off of Kraft Foods Inc. The company operates in North America and aims to be well positioned over the long term to deliver steady and reliable growth with primary focus on cash flows to fund dividends and reinvestment opportunities.

Kraft is facing challenges in its top-line growth. This article discusses the reason which has affected the food and beverage industry and the strategy followed by Kraft Foods to improve its margin. Also discussed is the point on why Kraft Foods is still a better investment option as compared to peers.

Decrease in Demand

Weak economic conditions have resulted in a weak job market and this has affected the revenue growth of the company. Kraft Food's revenue has decreased by 2% in a span of two years. However, the revenue decline trend is across the industry and should not be considered as a company-specific issue. The snapshot shows decreasing shoppers' trips over the years coupled with a shift in consumer mode of purchase. All retail outlets have faced a fall in shoppers’ trips except for dollar stores, and this is a broad indication of low demand due to a weak economy.

Source: Company Presentation

The positive point here is that Kraft, with its aggressive cost cutting strategy, has a competitive advantage over peers. The company’s effective cost management is evident from the fact that the company’s earnings have increased amidst a decline in revenue.

Playing with Margins

The financials of the company will give us a clear picture of the company’s strategy and growth plans. Revenue for Dean Foods (DF), Hillshire Brands (HSH) and Kraft Foods has been stagnant over the years.

But if we compare the quarterly margins Kraft has a better gross and net margin compared to peers. Gross margin for Kraft has increased to 35.8% in first quarter 2014 as compared to 32.3% in first quarter 2013. On an annual basis, the gross margin has improved to 37.5% in fiscal 2013 as compared to 31.6% in fiscal 2012.

An increasing gross, operating and net margin represents the company’s focus on productivity, efficiency and low cost production. In my view, implementation of lean six sigma programme and simplification of supply chain will help Kraft Foods to further expand its margin.

Kraft

1Q14

1Q13

FY13

FY12

Gross margin

35.80%

32.30%

37.50%

31.60%

Operating margin

20.7

17.9

25.20%

14.60%

Net margin

11.80%

10.10%

14.90%

9.00%

Cash Flow and Balance Sheet Analysis

Another positive point for Kraft Foods is the company cash flow from operations and the free cash flow trend. Both the metrics for the company has been positive over the years and a strong and an increasing cash flow supports solid dividend yield, which is likely to grow over time.

In terms of the balance sheet view as compared to peers, Kraft offers returns on equity, assets and capital better than industry average and peers. Good investment returns suggest a better managed assets and a better investment conversion ratio. This is positive from a long-term investment perspective. As economic activity gradually picks up, Kraft Foods will be best positioned to outperform its peers.

Parameters

Kraft

Hillshire

Dean Foods

Industry

ROE

61

44

41

35

ROA

12

9

8

10

ROC

19

18

21

14

Growth Plans in a Mature Market

The company is operating in a mature market with presence in 98% of the North American household. However, a leaner cost structure indicates that the company can use its savings in product innovations to meet the changing consumer preferences and shopping trends.

This implies that innovative methods need to be implemented to fulfil the customers' requirements. If we look at the company’s history, Kraft has always focused on innovation of its prime products and this has translated into a higher percentage of net revenue from new product innovation over the years.

Source: Company Presentation

In order to meet the shifting demand, Kraft has also reinvented its marketing strategy. The company has moved from a traditional broadcasting marketing methodology to a more customer-focused strategy.

The company has opened two new online stores with a presence in over 30 social networking destinations and 100 promotional websites. In my view, the e-commerce marketing will help Kraft in brand renovation and will also improve the top-line growth along with the EBITDA margin.

Conclusion

Kraft is a low-cost producer, which has been able to increase its bottom line in an environment where the top line is muted. Growing margins and better-than-industry-average returns make Kraft Foods an attractive buy. This is especially true after the recent dip in price, which can be considered a good entry point for a stock with stable and increasing dividend.

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Value Investor
A value investor.

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