Just about everyone has heard of Kraft Foods (KFT – Free Analyst Report) or its many household name products, which include Nabisco crackers and cookies, Philadelphia cream cheese, Oscar Mayer meats, Post cereals and, of course, Kraft cheese. Moreover, the company’s status as a Dow 30 component helps to elevate its profile above similar food processors. But just because a company is well known doesn’t make it a good investment. It’s important to take a deeper look.
For Kraft, that starts in understanding its business. Certainly, it’s large and has a diversified product lineup, but it also derives about 40% of its sales from outside of the United States—a fact that can be found in the company’s Business Description on the Value Line page, a free copy of which can be found here. (Opening this page in a new window or printing it out will help you to follow along with this article.) Although exposure to foreign markets can be a double-edged sword at times, over the long-term it is a decided positive, particularly since the U.S. market for branded food products is largely saturated. Being able to enter growing markets like China and India helps to support long-term top- and bottom-line growth.
Sales and earnings growth over the past five years has been something of a mixed bag. As the Annual Rates box shows, revenues in that span increased, on average, by 6.5% annually, but earnings only inched up 1.5%. That’s not a particularly good showing, as only a small portion of the top-line growth fell down to the bottom line. Performance over the trailing 10 years was better on the margin front, with more revenue being converted to earnings. As our projections for future earnings and revenue growth in this box show, we expect the next three to five years to look more like the trailing ten-year period than the trailing five-years, with sales growth slowing some to 3.5%, but earnings picking up to an annual average of 8%.
This improvement comes in the form of better net profit margins. Indeed, if you examine the historical portion of the statistical array, you’ll note that net profit margins in the 2002 to 2006 span were above 9%—often well above that level. In more recent years they have fallen into the 6% to 7% range. Small changes here can have a significant impact on earnings, and our expectation that profit margins will head back above 9% over the 2013-2015 time frame is a significant driver of our expectation for an increase in bottom line growth.
On an absolute basis, we expect annual earnings to jump from the $2.00 a share area today to around $3.00 in three to five years. That’s a nice jump, one that acquisitions should help to support. Most recently, the company acquired Cadbury. As the analyst comment notes, the integration process is going smoothly. Moreover, the acquisition is expected to reduce overall costs by $675 million; this is on top of the cost savings that both Kraft and Cadbury had achieved prior to the deal. These savings help underpin our profit margin expectations. In fact, it’s Kraft exposure to developing economies like Brazil, Mexico, Russia, and the aforementioned China and India that will allow for the expected synergies and savings. Indeed, one of Kraft’s biggest assets is its distribution system, which spans the world. The ability to take a collection of well-known products, like those acquired in the Cadbury deal, and plug them into a powerful distribution system, was a vital aspect of this deal—without the distribution system, the acquisition wouldn’t have made as much sense.
Supporting this worldwide system while also making important acquisitions isn’t cheap. Which helps explain why Kraft’s capital structure—the Capital Structure box is located on the left hand side of each Value Line page—is cut nearly equally between debt and stock. This level, however, isn’t worrisome for a company that has a stable and recurring revenue stream and solid cash flow. Moreover, the current ratio (created by dividing Current Assets by Current Liabilities, both of which can be found in the Current Position box on the left side of the Value Line page) is solid, if not exceptional, at about 1.0. This suggests that the company has the financial capacity to pay off near-term liabilities without major difficulties. A stable revenue stream and solid balance sheet support the A+ Financial Strength rating we’ve assigned the company—this rating can be found at the bottom right of the Value Line page.
This solid financial position also helps explain Kraft’s top-notch Safety Rank (1). And the high marks for Safety and Financial Strength both help provide a level of comfort with the company’s 4% dividend yield, about double the 2.1% average of all dividend paying stocks Value Line covers as of early August (a number that can be found on the front of the Index section of each issue). Although the Historical Array clearly shows that the amount of dividends paid out of profits has increased in recent years, that’s a trend we expect to reverse shortly, as the company comes back into the 50% of earnings payout range. The dividend is an important component of our total return projections over the three- to five-year period of between 15% and 20%, which suggests a price target in the $45 to $55 per share range (these statistics can be found in the Projections box to the left of the graph) with the dividend increasing from $1.16 a share to about $1.40 (year-by-year dividends and estimates can be found in the Historical Array).
Of course, the stock is currently ranked to mirror the broader market (as measured by the 1,700 companies Value Line tracks—these companies make up the vast majority of the stock market’s total value) over the next six to 12 months. That said, the company’s top notch Safety Rank and low beta (0.65, as shown beneath the Ranks at the top left of the page) should be appealing to risk-conscious investors, especially when coupled with the healthy dividend yield and solid longer-term prospects for earnings and revenues.