Kraft Foods (NYSE:KFT) is the world’s second largest food and beverage company after competitor Nestlé (OTC:NSRGY). It also competes with PepsiCo (NYSE:PEP), General Mills (NYSE:GIS) and Kellogg (NYSE:K). Although the company manufactures both food and beverages, beverages account for only about 13% of our $35.64 price estimate for Kraft’s stock, which is around 15% higher than market price.
We estimate that chocolate, candy & gum constitute around 32% of our price estimate, with snacks generating 18% and grocery 17%.
In this article we identify three key issues to watch in 2011.
1. Starbucks Fall-Out
First is the fall-out with Starbucks and ensuing legal battle. As we’ve previously discussed, the real downside for Kraft from this development is actually quite limited (See Kraft’s Starbucks Partnership – Limited Impact on Kraft Stock).
We believe that Kraft will be able to retain market share in the packaged coffee space by growing its in house coffee brands like Jacobs and Maxwell House. Potential downside to Kraft’s market share could emerge if Starbucks partners with another distributor like Green Mountain Coffee Roasters or decides to distribute its product independently.
2. Cadbury Acquisition
Second is the Cadbury acquisition, which we’ve previously examined (See Kraft $4 Billion Sweeter from Cadbury Deal).
Kraft has benefited from this acquisition by obtaining a foothold in the chocolate, candy & gum market, where its share increased from 5.4% in 2009 to 15% in 2010 as a result of the acquisition. We expect this metric to further increase to around 17% by the end of our forecast period.
See our full analysis and $35.64 price estimate for Kraft.
The EBITDA margin for Kraft’s chocolate, candy & gum division decreased from around 17% in 2005 to 10% in 2008, largely due to rising raw material prices and the inability to pass on these costs to customers, as well as increasing expenses.
However, EBITDA margin for this segment increased in 2009 due to large scale adoption of cost cutting measures. Our base forecasts include the expectation of further margin improvement stemming from additional cost synergies. However, if Kraft is unable to realize significant cost synergies from the Cadbury acquisition (a concern given different business cultures and top level defections sparked by the deal), there could be real downside to our forecasts. [1]
If EBITDA margin for this segment only increases 14% by the end of our forecast period (vs. our roughly 17% base estimate), it would imply 7% downside to our $35.64 price estimate for Kraft’s stock.
3. Rising Input Costs
Third is the challenging growth environment magnified by rising input costs. With food price inflation expected to increase by 2-3% in 2011, distributors like Kraft will be forced to increase prices.
Weak consumer spending trends in addition to increasing raw material prices can pressure Kraft’s margins as consumers not willing to meet price increases shift away from premium brands (See Rising Commodity Prices Can Limit Kraft Upside).
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