Kraft Foods $62 Fair Value Bolstered By Productivity Gains And Strong Brands

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KRFT: Kraft Foods logo
KRFT
Kraft Foods

Kraft Foods Group (NASDAQ:KRFT) shares have rallied by over 10% in the last month. The stock is currently trading at more than 10% discount to our $62 price estimate. We attribute our valuation premium to the company’s strong brands, high household penetration and increasing profitability.

Kraft Foods Group manufactures and markets packaged food products, including beverages, cheeses, convenient meals and various grocery products. The company primarily deals in the North American markets with the majority of its sales coming from the U.S. and Canadian markets. It generates annual revenues topping $18 billion and has guided for adjusted earnings per share target of $2.75 for 2013.

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Popular Brands, High Penetration Driving Top Line

All of Kraft’s 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 such as 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 the company’s many popular brands earn more than $500 million in revenue each year and contribute close to 70% to the company’s total net revenues. It also enjoys household penetration of 98% and 99% in the U.S. and Canada respectively. [1]

We see these factors as the key ingredients of our top line growth estimates of ~3.5% CAGR for the company.

Productivity Gains Driving Profitability Higher

Kraft’s first quarter earnings announcement has been a trigger to the stock’s recent rise. The key highlight of the earnings release was a sharp 120 basis points improvement in its operating margins, which increased to 17.8% despite higher restructuring charges of $119 million and increased marketing expenses. This can primarily be attributed to the company’s ongoing productivity improvement program.

Kraft is tapping the Lean Six Sigma principles to drive productivity in the 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. [1]

Driven by an impressive performance on productivity gains during the first quarter, we have revised our adjusted EBITDA forecast for the company. We expect 2013 company-wide adjusted EBITDA margin that excludes non-operating and non-cash charges to rise by almost 200 basis points over last year. Although going forward, profitability improvement is expected to shrink 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.

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Notes:
  1. CAGE Conference, www.kraftfoodsgroup.com [] []