Kraft Foods Group Inc.’s (NASDAQ:KRFT) shares rose following its results. The company’s first quarter diluted earnings per share (EPS) of $0.76 was down 7.3% as growth from operations (increased EPS by $0.14) was more than offset by higher restructuring costs (decreased EPS by $0.06) and interest expense (decreased EPS by $0.13). However, Kraft’s net revenues in the first quarter grew 2.1% y-o-y to $4.5 billion primarily driven by favorable impact of 2.4% from volume/mix gains, partially offset by lower pricing. Its earnings before interest and taxes (operating income) grew significantly by 9.2% y-o-y as higher restructuring costs were more than offset by cost reductions from ongoing productivity improvement program. Kraft also reaffirmed its full year diluted EPS guidance of $2.75 per share, which includes planned restructuring costs of approximately $300 million. 
New Products, Marketing Support Drive Revenue Growth
Kraft has been focusing on innovation in both product as well as packaging and marketing to revitalize its iconic brands. It generated around 13% of total net revenue in 2012 from new products, up significantly from around 6.5% in 2009. Just to emphasize, that implies incremental net revenues of approximately $1.2 billion during 2012. Incremental revenues were supported by both new product innovation as well as increased marketing support to its brands. In 2012, the company’s advertisement costs were up by around 20% y-o-y.
The food and beverage company continued to gain form the above strategy during the first quarter as well. Revenues from its Velveeta cheesy skillets, that belong to the grocery division were up more than 30% year on year. The fact that the product also recorded double digit growth throughout 2012 suggests that the company has really been able to strike a chord with consumers in the dry dinner mixes category. Lunchables also continued to grow strongly during the quarter driven by Smoothies innovation and ramped-up marketing. The company plans to spend at least $25 million on new product launches this year, including a Kool-Aid extension of the liquid water enhancer category it created with MiO.
We expect Kraft to continue to post sustained revenue growth in the long run backed by rationalized allocation of R&D and marketing resources across its brands as seen over the last couple of years.
Productivity Gains Drive Profitability Higher
Kraft’s revenues grew modestly by 2.1%, led by favorable volume mix as prices were down year on year. However, its operating margins improved by 120 basis points to 17.8% despite higher restructuring charges of $119 million and increased marketing expense. This can be attributed to the company’s ongoing productivity improvement program.
Kraft is tapping the Lean Six Sigma principles to drive productivity in supply chain and manufacturing processes. It targets to deliver net productivity as a percentage of cost of goods sold (COGS) of at least 2.5% in 2013. The company is also acting to reduce its overhead costs as a percentage of net revenues significantly. 
Going forward, we expect the profitability improvement metric to get smaller in magnitude as comparisons start getting tougher. However, leaner manufacturing and supply chain processes and sustained lower overhead costs will ensure stable margins for the company in the long run.Notes:
- Kraft Foods Group, Inc. Reports First Quarter Results, ir.kraftfoodsgroup.com [↩]
- 2013 Consumer Analyst Group of Europe Presentation, ir.kraftfoodsgroup.com [↩]