Price-Based Competition In The Grocery Segment Weighs On Kraft

Kraft Foods Group’s (NASDAQ:KRFT) performance in the grocery space weighed significantly on its overall performance last year. The company’s sales in the grocery segment declined by ~3% y-o-y, as it lost market share amid intense price-based competition from the private label brands. We expect similar market conditions to continue to weigh on its results this year as well. However, shrinking price gap between the private labels and Kraft’s national brands coupled with growing marketing expenditure by the company is expected to reduce the intensity of price-based competition in the long run. ^[1]

In our analysis, we have combined the results of Kraft’s Enhancers and Snack Nuts division, which sells Planters nuts and peanut butter, and salad dressings with the Meals and Desserts division, which primarily includes results from the sale of Kraft’s namesake macaroni and cheese and Jell-O desserts, to form the Grocery division. Although the division contributes around 25% to the company’s total sales revenue, it makes up almost 40% of our valuation estimate for the company because of higher profitability. ^[1]

We currently have $55 price estimate for Kraft, which is almost in line with its current market price.

The Rise of Private Labels

The most prominent trend in the grocery segment has been the surge of private label brands over the past few years. It kicked in when the U.S. economy entered into a recession in 2009, forcing consumers with reduced spending capacity to opt for cheaper grocery brands. However, despite a significant recovery in the U.S. economy since 2009, the private label brands continue to attract consumers, resulting in intense price-based competition for national brands including those offered by Kraft. ^[2]

The effect of this trend was visible in Kraft’s 2013 results. According to our estimates, the company’s grocery sales declined by ~3% y-o-y last year, led by salad dressings and gelatin desserts categories. In the salad dressings category, Kraft suffered not only because of the stiff competition from private label brands but also due to the growing demand for labels that offer fresh, organic salad dressings. As a result of which Kraft’s budget brands got squeezed. ^[3] On the other hand, sales of Jell-O, a very popular brand in North America that is generally used as a synonym for gelatin desserts, have also been on a decline over the past few quarters due to increased competition in the overall snacks category, especially from the private label brands. ^[4]

This could be partly attributed to the fact that the private labels have not only worked a lot on improving the quality of their products but also on building their brand equity through investments in innovation, packaging and consumer engagement. Additionally, the lower-income consumers that have not bounced back as much as the ones in the higher income bracket continue to remain cautious of their food budget. According to Nielsen, sales of private label brands have grown more than twice as fast over the past three years, compared to the national brands. ^[2]

According to our estimates, Kraft’s grocery market share has declined by more than 180 basis points since 2010 at an average rate of around a 60 basis points per year. If this rate were to continue in the long run, there could be around 10% downside to our price estimate for the company. However, we currently expect the decline in Kraft’s grocery market share to subside over the next couple of years as the pricing gap between private labels and national brands narrows and the company increases its marketing push behind the ailing brands. Currently, private labels are priced at around 20-25% lower than the national brands on an average. The price gap has already come down quite a bit over the past few years, as prices of the private label brands have increased at a much faster rate. ^[5] Additionally, Kraft has also been increasing its spending on advertising and marketing, which is expected to provide a boost to its ailing brands such as Jell-O. Last year, the company spent 4.1% of its net sales revenue on advertising, compared to just 3.1% in 2010.

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1. Kraft SEC Filings, sec.gov [↩] [↩]
2. Groceries Are Cleaning Up in Store-Brand Aisles, nytimes.com [↩] [↩]
3. Salad Dressings Are Getting Squeezed, wsj.com [↩]
4. Kraft Launches Comeback Plan for Jell-O, adage.com [↩]
5. Private Labels Borrow Brand Tactics To Grow Market Share, foodnavigator.com [↩]