Kraft Split No Guarantee of a Success, Too Early to Assess Impact

Kraft Foods (NYSE:KFT), which left the investors baffled when it announced that the company will split into two earlier in August this year, named the Chief Executives for the two yet to be named companies on Monday. Irene Rosenfeld, who is the current CEO of Kraft Foods, will head the Global Snacks Division whereas Anthony Vernon, executive vice president and president of Kraft North America, will head the North American Grocery Division. ^[1] The spin-off is expected to be complete by the end of next year. Kraft currently competes with players like PepsiCo (NYSE:PEP), General Mills (NYSE:GIS) and Kellogg (NYSE:K).See our full analysis for Kraft here

The company surprised the market with news of a split as the announcement came just 18 months after Kraft’s hostile acquisition of Cadbury. Kraft feels that the company has grown in two different directions and therefore it is logical to split the company into two. The Global Snacks Division is the faster growing division with $32 billion in revenues and a significant presence in emerging markets. The North American Grocery Division, on the other hand, is the slower growing division with revenues of $17 billion. ^[1]

The Upside

The company feels that the spin-off will offer investors the best of both worlds. Kraft can now take advantage of Cadbury’s excellent marketing and distribution networks in emerging markets like India, China and Brazil to help propel the growth of new products it plans to launch in these economies. Already, we see emerging markets as a significant growth driver for Kraft, and the company feels that the growth of the Global Snacks Division is somewhat nullified by the stagnant nature of the North American Grocery Division.

The North American Grocery division might be growing more slowly, but it is the one with higher profit margins. Sales are relatively stable and market penetration is high. Therefore, we expect it to have a healthy dividend payout ratio. Thus, splitting the company into two would give the investors access to the less-volatile, higher dividend yielding Grocery division as well as the more volatile, higher-growth Snacks division.

The Downside

At the time, when the high commodity prices are eating up the margins of companies around the world, the division would reduce scale for both of the companies. The lower scale might leave the two yet-to-be-formed companies in a less advantageous position in terms of getting the best prices for raw materials. Similarly, negotiating power with retailers could be reduced somewhat now that certain products would be missing from the portfolio of each company.

The company has not yet provided details on how it plans to split the massive $30 billion debt, the large part of which was undertaken to acquire Cadbury. ^[2] A large debt obligation on the Global Snacks Division’s balance sheet will make it harder for the company to raise money or undertake further debt in the future, which could really stymie the growth prospects. Moreover valuing the independent companies would need to take this debt split into consideration.

We currently estimate a $34.60 price for Kraft Foods, which is 5% below the current market price.

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1. Kraft Hashes Out Details of Split, WSJ, November 6, 2011 [↩] [↩]
2. Kraft split sets up hot recipe for valuation, MarketWatch [↩]