Kraft Foods Group New Coverage: $55 Trefis Price Estimate

In October 2012, Kraft Foods split into Mondelez International (NASDAQ:MDLZ) and Kraft Foods Group (NASDAQ:KRFT). Mondelez International operates the international snacks business of the parent company with annual revenues to the tune of $32 billion, including popular brands such as Oreo cookies, Trident gum and Cadbury chocolates. Kraft Foods Group manages operations in North America with annual revenues of around $18 billion.

Kraft Foods Group manufactures and markets packaged food products, including beverages, cheeses, convenient meals and various grocery products. It primarily deals in the North American markets with the majority of its sales coming from the U.S. and Canadian markets. The company reports its earnings segmented into five divisions namely, grocery, cheese, beverages, refrigerated meals and international & foodservice.

Each of its divisions market some very popular brands in their respective segments. For example, the grocery division markets Kraft Macaroni and Cheese, Planters nuts and Jell-O refrigerated desserts while the cheese division markets leading brands Philadelphia and Velveeta. Other popular brands operated by the company include Oscar Mayer processed meats, MiO liquid concentrate and Capri Sun packaged juice drinks. Nine of Kraft’s many brands earn more than $500 million in revenue each year and contribute close to 70% to the company’s total net revenues. ^[1]

Trefis is initiating coverage for the Kraft Foods Group with a $55 price estimate.

See Our Complete Analysis For Kraft Foods Group

Key Markets Set To Grow With Recovering Economy

According to our estimates, the grocery division contributes the most (around 38%) to the company’s value. The division primarily deals in nuts, peanut butter, macaroni and cheese dinners, packaged desserts and other grocery products. We forecast the market for these products in the U.S. and Canada, to grow at a 3.5% CAGR over the forecast period. Our forecast is based on broader macroeconomic recovery in the U.S., marked by improving consumer index and growing non-farm employment rate, which is expected to drive higher consumption and better volume-mix in the long run. Other factors like growing market for salad dressing attributed to increasing interest among consumers towards healthier diets, and rising demand for fusion and ethnic cuisines are also expected to drive the grocery market higher.

As per our analysis, the second most valuable division of the Kraft Foods Group is cheese. According to the data collected by the USDA economic research service, annual cheese consumption per capita in the U.S. has grown steadily from around 14.3 pounds in 1975 to 33.5 pounds in 2011, at a 2.4% CAGR. Cheese consumption per capita in the U.S. was at its peak in 2007 at 33.64 pounds, indicating the impact of the recession on consumption of cheese in the last few years.

Some of the most visible trends contributing to the steady growth forecast in consumption of cheese are:

1) Growth in the U.S. fast food market led by increasing snacking habit among time-constrained consumers. This trend has contributed significantly to the growth in consumption of cheese as it forms a vital ingredient of nearly all fast food preparations, ranging from sandwiches to pizza.

2) Growing acceptance of ethnic cooking such as Italian and Mexican, which use substantially more cheese has also led to higher per capita consumption of cheese.

3) Cheese consumption has also increased due to its versatility and adaptability to recipes and increasing varieties.

Cheese prices have increased at a 3.3% CAGR over the past 100 years. ^[2] Although, food prices are highly volatile, we can safely assume a 2% CAGR in real prices of cheese over the forecast period. Price increases coupled with a 0.75% population growth rate and the 1.75% CAGR in the consumption of cheese per capita, we can conservatively forecast around 3% CAGR in the U.S. cheese market over the forecast period.

Other markets served by the company are the North American non-alcoholic beverages, refrigerated meals and the foodservice markets. Each of these are expected to grow at 2.5-4% CAGR over the forecast period.

Kraft Is Positioned Well To Leverage These Growing Markets

Kraft’s leadership in each of the operating segments is driven by its key brands like Kraft macaroni and cheese, Philadelphia, MiO, Oscar Mayer, and many more. Furthermore, increased focus on marketing visible form higher marketing expense as a percentage of revenues at 3.5% in 2012, as compared to 2.9% in 2011, and higher revenues from new products as a percentage of total revenues at around 13% in 2012, as compared to 6.5% in 2009, highlight successful innovative product launches and better product management in terms of effective marketing. ^[1] Below are a few examples to back these statistics:

1) In 2011, Kraft launched the MiO water enhancer, whose sales touched $100 million within the first nine months of launch. The company extended the success of this launch into MiO Energy in 2012. MiO Fit made a Super Bowl Debut with an advertisement featuring actor and comedian Tracy Morgan, in January 2013. In a short span of two years since launch, the brand has gained significant sales momentum, as 2012 revenues were up 67% y-o-y. The company also extended its Crystal Light brands offerings to include zero-calorie liquid drink mix in six flavors.

2) In 2011, Kraft extended the Planters line up to include peanut butter. The company was able to grow its market share to around 5% in the $1.8 billion U.S. peanut butter market in a period of 6 months. ^[3]

3) In May 2012, Oscar Mayer announced a new line of meats called Selects that have no artificial preservatives, flavors or colors. This is an important move as consumers have cited presence of preservatives as a reason for their perception of packaged meals being low on nutrition value.

4) In December 2012, the company introduced Philadelphia Spicy Jalapeño Cream Cheese and added a couple of flavors to the Philadelphia Indulgence Spread. Various new varieties of string cheese were also added to the company’s strong line up. ^[4]

Profitability In Focus Amid Rising Costs

We expect better volume mix backed by the recovering U.S. economy to drive better profitability for food and beverage companies in general. Kraft’s strong brand equity in all its operating segments is expected to empower it with enhanced pricing control, required to offset rising commodity costs. Kraft’s key brands continued to outperform in the market during 2012 – Kraft macaroni and cheese revenues went up 11%, Velveeta franchise grew 12% and MiO sales grew 67% y-o-y. A significant portion of this revenue growth can be attributed to higher net pricing, which more than offset higher raw materials costs. Moreover, the company’s ongoing productivity and efficiency improvement plans are also expected to improve its profitability in the long run. Kraft is targeting net productivity as a percentage of cost of goods sold (COGS) to be at least 2.5%. It was 1.5% and 2.8% in 2011 and 2012 respectively. The company is also planning to improve its efficiency by reducing its overhead costs as a percentage of net revenues from over 12% to around 8%. ^[1]

However, volatile commodity costs remain the single biggest threat to the profitability of the firm’s operations. Kraft uses commodities including dairy products, coffee beans, meat products, wheat, corn products, soybean and vegetable oils, nuts, sugar and other sweeteners as raw materials. According to the Bureau of labor statistics, the prices of milk have risen at a CAGR of 4%, beef prices have shot up at a CAGR of 6%, while the prices of coffee and chicken have risen at a CAGR of 15% and 5% respectively, over the period of last three years. The company is also expected to increase investment in innovation and promotional strategies for new products as it tries to maintain and advance its market share in the key categories. In 2012, the company’s advertisement costs were up by around 20% y-o-y. ^[5] This is expected to put additional downward pressure on margins going forward. Overall, We forecast the company-wide adjusted EBITDA margins to remain relatively stable in the long run at around 20% mark with a positive bias.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. CAGE Conference, www.kraftfoodsgroup.com [↩] [↩] [↩]
2. Average Food Prices: A Snapshot Of How Much Has Changed Over A Century, www.bls.gov [↩]
3. Kraft’s Planters Heads For The Peanut Butter Aisle, www.businessweek.com [↩]
4. Kraft Keeps Innovation Flowing With 40+ New Products, www.kraftfoodsgroup.com [↩]
5. Kraft 2012 10K, www.kraftfoodsgroup.com [↩]