Kraft (KFT): The most important news regarding Kraft recently is the company's decision to split up its businesses. The split will divide Kraft's North American grocery business from its international snacks business. Its global snacks business is the company's high growth, high revenue business. Brands in this segment include Oreo, Trident Gum, Wheat Thins, and other well-known snacks. By combining the company's European and developing markets units with its North American confectionery and snacks unit, the company plans to take advantage of continued strength in mature markets, along with the rapid growth of its current and future products in emerging markets. The company expects $32 billion in revenues from this segment, 75% of which will be derived from international operations. Its spinoff, the North American grocery segment, is expected to rake in $16 billion in revenues. Brands in this segment include highly recognized products such as Maxwell House Coffee, Jell-O, Cool Whip, and Kraft Singles Cheeses.
Kraft's grocery business spinoff is, at least at first, likely to be the higher dividend payer. While the segment is notorious for its low margins and slow growth, it does produce significant cash flows, and its maturity reduces capital expenditures. Its success will still depend on management's ability to reduce costs, strategically allocate as little capital as possible, and continually innovate. Given Kraft's current dividend of 3.30%, a dividend approaching 4% appears realistic given the nature of the business.
The remaining business aims to be an investor's dream; high growth, high margin, and mega revenues. The segment will benefit from rapid population growth in developing markets, along with growth in brand recognition and overall market penetration. There is significant upside in the business, and the international diversity is a major plus. This company is also likely to pay a dividend, albeit a shrunken one, given the fact that management is likely to find higher return investments for their capital.
Barring shareholder denial, Kraft hopes to finish the split by the end of 2012. Kraft's current CEO, Irene Rosenfeld, will remain the CEO of the global snacks business. The spunoff grocery business' manager is yet to be decided.
The move appears to make a lot of sense, but the risk lies within the fact that the inherent risk of high growth markets will no longer be mitigated by the cash producing, mature grocery business. The decision should prove to be successful, and management seems more than capable of producing a result in which shareholders benefit. Mrs. Rosenfeld owns nearly a million shares, while Warren Buffett owns 5.63% of all outstanding shares. As is common with spinoffs, current shareholders of Kraft will likely receive shares of the new company, while the value of the original company will reset. Investors can then decide the best course of action.
As a long-term investor, looking at the next year doesn't fit my investing philosophy. Therefore, this split plays a major factor in my decision. I'd be surprised to learn that any pure income investors are shareholders of the current Kraft. The 3.30% dividend that Kraft sports is generally too low for income investors. If you are one, it appears the grocery segment is likely not the best investment. It's not Kraft's favorite business, why should it be yours? There are better places to find yield. If you are an investor for equity appreciation, the remaining business should be a great place to find success. High margins, good economic fundamentals, great products, and competent management will be a recipe for long term earnings growth and success, and there should at least be a moderate dividend to boot.
Given the company's plans, valuation of Kraft is difficult. Based on current factors, KFT trades at 20 times last year's earnings, 14 times next year's earnings, and 1.59 times book value. The company has $26 billion of intangible assets, which speaks volumes about its brand recognition. Kraft is able to reap massive profits simply due to the popularity (consumer loyalty) to its brands, thus increasing its efficiency.
The company pays shareholders a 3.30% dividend (which has grown 3% per year over the last five years; a little more than inflation).
Kraft has nearly $30 billion in long term debt, which is very high considering the $1.55 in annual free cash flow. With a debt to equity ratio of 75.82, the company's balance sheet is highly leveraged.
General Mills (GIS): On Wednesday, General Mills announced above-estimate earnings of $.64 per share on revenue of $3.85 billion, which was $50 million above estimates. The company's median target for fiscal 2012 is $2.60, which would equate to a P/E ratio of 14.77 based on today's share price.
General Mills' business is largely attached to cereal products. Cheerios, Chex, Lucky Charms, and Fiber One are all large pieces of GIS' product line. Outside of the cereal business, Haagen-Dazs, Totinos Pizza,and Yoplait Yogurt are all big sellers. Incidentally, Yoplait International was acquired July 1st.
General Mills saw about 3% in U.S. sales growth last quarter, in addition to a very promising 30% internationally.
GIS has rolled out several wildly successful products recently. The most exciting addition has been its Greek yogurt segment. GIS has seen incredible growth in this segment, and its yogurt business as a whole produces $4 billion in annual revenues.
Analysts have begun to pile on the proverbial bandwagon recently, as Longbow and Stifel Niclaus have increased Its price targets to $48 per share.
Dividend growth at General Mills has been superb. The company's 5 year growth average is 11.75% annually, and the company maintains that on a payout ratio based on earnings of only 42%.
Trading at about 14.7 times earnings, it's significantly cheaper than Kraft on that basis.
General Mills has about $6 billion in debt, which is a bit hefty considering that it only generates about $560 billion in free cash flow per year, and much of that is used to pay for dividends. While the company has significantly less debt than Kraft, its Debt to Equity ratio is over 100.
Conclusion
Both diversified food producers have held up well during these times of painfully slow (or no) growth. I am a big supporter of Kraft's breakup plan. The remaining company is going to be a leveraged play on the growing food needs of the world's most rapidly developing markets. While debt levels remain high, it may be difficult to meander through another collapse. Granted, the remaining company will be at significantly less risk than those operating in mature markets. The key is that regardless of the state of the global economy, population growth in developing markets is rampant, providing a constantly growing consumer base. Kraft's dividend yield after the spinoff remains a mystery, but one would have to guess that it shouldn't change too much from the current 3.30%.
General Mills also operates internationally, but much of its sales come from the United States and the European Union. GIS's recent success has given the stock some momentum, and the company appears well positioned even for a slow growth or even recessionary environment.
Over the long term, either company should be an excellent investment. With current yields of 3.20-3.30%, investors only need about 6% equity appreciation per year to outperform the market in most years. If Kraft's plan does indeed proceed successfully however, its pure exposure to rapidly growing markets as an experienced company is likely to provide investors serious earnings growth. I'd go with Buffett on this one: Kraft.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KFT over the next 72 hours.
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