Worried that the Market is Overbought? Play Defense with Kraft Foods

KFT: Kraft Foods logo
Kraft Foods

Submitted by Investing Daily using the contributor tool

Conventional wisdom holds that consumer staples names such as food and beverage manufacturers are slow-growth stocks that hold up best when the market swoons and lag when equities rally.

The S&P 500 Consumer Staples Index has soared nearly 130 percent since 2000—compared to the 17 percent gain posted by the S&P 500—and outperformed its parent index in all but the strongest bull markets. These outsized returns were produced with significantly less volatility.

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Consumer staples and health care, two of the most defensive groups in the S&P 500, are among my favorite sectors. They’re a great way to enjoy strong growth and low volatility.

With information technology and other market-leading sectors increasingly vulnerable to a pullback, investors should take profits on high-flyers and reallocate the proceeds to defensive names that are poised to take off.

Here’s a look at one stock that fits the bill.

The largest food manufacturer in the US, Kraft Foods (NYSE: KFT) is behind some of the world’s most iconic brands, including Oreo cookies, Trident gum, Planters nuts, Philadelphia Cream Cheese and, thanks to a USD19.4 billion acquisition in 2010, UK-based Cadbury chocolates.

As with Sara Lee Corp (NYSE: SLE), which I profiled here, the investment case for Kraft Foods rests on its imminent split into two companies: a slow-growing, North American grocery business that pays an ample dividend and a rapidly growing international snack food company. Kraft plans to separate its financial statements in the second quarter of 2012 and will finalize the split before the end of the year.

In North America, packaged-foods manufacturers have suffered from weak volume growth because of a sluggish economy and consumers’ preference for value brands. Kraft Foods’ unit sales were off 0.6 percent in 2011, but this disappointment wasn’t as bad as the 2.4 percent decline for the US food and beverage industry as a whole.

The good news: Kraft Foods has generated growth in a weak economy by boosting prices, cutting costs, introducing new products and eliminating underperforming products. Although sales volumes were off overall, net revenues for its “power brands” were up 4.5 percent, aided by a significant boost in marketing.

New product introductions in 2011 were mainly extensions of existing brands such as a line of chocolate Philadelphia spreads, new “healthy lifestyle” meat products under the Oscar Mayer line and a spicy Ritz cheese cracker. Higher-margin new products accounted for about 9 percent of net revenue in 2011, up from 6.5 percent two years ago.

The North American grocery business isn’t likely to be a fast grower, but can continue to generate solid cash flows and reliable profit margins. The company plans to institute a substantial dividend payout for this business, with a likely yield of 4 percent or higher.

Meanwhile, Kraft’s international snack foods business is the growth play, generating 44 percent of its $35 billion in total revenue from developing markets. The company’s biscuit brands portfolio—including Oreo, LU and belVita—saw net organic revenue growth of 9 percent in 2011, with developing markets up at a double-digit pace and developed markets posting respectable growth in the mid-single digits. In Russia and China, biscuit sales were up roughly 40 percent in 2011. For more growth plays, check out my free growth stock picks report.

In chocolates, total sales were up 6 percent but developing market sales were up well into the double digits. In India, for example, the company has generated strong growth in this category by distributing refrigerated displays known as Visi Coolers to all parts of the country. These chilled displays maintain chocolates at their ideal temperature even in the hot Indian climate.

The planned Kraft split will heighten the value of the firm’s brands and its growth potential in emerging markets.