In our preview of the Kraft Foods Group‘s (NYSE:KRFT) fourth quarter and year end 2014 earnings report, we focus on two issues that plagued the company through 2014. Commodity prices, which constitute a large part of the company’s direct costs, saw significant volatility last year. Also, the company faced challenges in the execution of its sales and marketing and supply chain strategies.  We believe that the commodity headwinds have subsided, but the execution issues may have continued to bother Kraft in Q4 2014 as well.
We have a price estimate of the Kraft’s stock of $63, which is slightly below the current market price.
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Commodities In Focus
Some of the most important raw materials for Kraft are coffee, sugar, milk and wheat. In our September 2014 article on the impact of the coffee price on Kraft, we had described its coffee situation as a lose-lose scenario. Our analysis was inspired by the rising trend in the coffee price up to Q3 2014. Since then, however, the coffee price has come down by about 30%.  This fall was precipitated by the talk of improvements in supply from Brazil, the world’s largest producer of coffee.  Falling coffee prices help Kraft maintain its margin for its coffee products.
Sugar prices also saw a fall in Q4 2014, from an early October quarterly high of around 17 cents per pound to an end-of-year figure of 15.  A major factor influencing the price is the possibility of the reintroduction of an export subsidy for sugar by the Government of India. The country is estimated to have more than 2 million tons of export surplus. This could hit the market if the Government decides to provide the subsidy to exporters. 
Lastly, milk prices saw a more moderate Q4 decline of around 6%.  This was partially driven by rumors that China was over-stocked on milk powder, as well as Russia’s trade sanctions against the U.S. and Western Europe.  The wheat price, on the other hand, rose by over 30% in Q4. 
Understanding The Execution Issues
On the Q3 earnings call, management pointed out some execution issues. Pricing was stagnant in the cheese and meat segments, with poor brand building cited as the reason. Further, the company was having to spend significantly just to retain its market share.  There were issues on the productivity front as well, with the company anticipating a shortfall from the targeted 2.5% productivity gains. Certain product recalls, as well as higher than expected product innovation costs, contributed to this shortfall. It will be interesting to see how the company has progressed on these fronts since then. Notes: