Income investors got an early holiday gift in October, when
Kraft was split into two: A high-growth international snack-food
Mondelez International (Nasdaq: MDLZ)
Kraft Foods Group (Nasdaq: KRFT)
, a North American packaged-food business that's more focused on
paying nice dividends to shareholders.
The deal was structured as atax-free spinoff , with Mondelez
shareholders receiving one Kraft share for every three
Mondelezshares held. At the time of the spinoff, Kraft was North
America's fourth-largest packaged-food company, with reported
revenue of $19 billion in 2011. As two separate entities, Mondelez
now owns the Oreo, Cadbury and Nabisco snack food brands, while
Kraft hung on to its familiar household U.S. brands -- Oscar Mayer,
Miracle Whip and Velveeta.
The deal was intended to unlock shareholder value, and now the
"new" Kraft is a far more enticing incomeinvestment than the "old"
Kraft. For starters, the $27.4 billion company was launched from a
position of strength, with three-quarters of its revenue earned
from product categories where Kraft is either themarket leader or a
In addition, as a now leaner company, this new Kraft is now able
to focus on profitable growth and on returningcash to investors.
This can already be seen in its laser-focuseddividend policy. For
example, the new Kraft pays a richer annual dividend ($2 versus
$1.16 per share) and has a betteryield (4.4% versus 3%). In
addition, the new Kraft is committed to 5-9% annual dividend
growth, while the old Kraft had hiked the dividend only twice in
the last five years. To be fair though, the company rarely raised
dividends because it was too busy with its aggressive overseas
expansion, which consumed large amounts ofcash flow each year
(Kraft plowed back billions into international acquisitions -- such
as its $10 billion purchase of Cadbury-- and expansions in Europe
Here are six other reasons Kraft is a top income stock worthy of
consideration in every investor's portfolio...
On average, Kraft brands have twice themarket share of the
next branded competitor. The company estimates 98% of U.S.
households have Kraft products in their refrigerator. The
reliableearnings produced by its iconic brands make Kraft a
true cash-generating machine. Each of the 10 brands Kraft
owns generates at least $500 million in annual sales.
Kraft produces more than $4 billion of cash flow annually and
has better than two-fold coverage of the dividend.
The company is content owning a mature, but highly
profitable North American operation, and has no plans to
siphon off cash to invest overseas. Instead, Kraft plans to
reinvest 50% of cash flow in operations and return the other
50% to investors through share repurchases and the dividend
Currency risk removed
Another key advantage of the Kraft spinoff is greater safety
and predictability of results due to an exclusive North
American focus. There is now minimal exposure tocurrency
fluctuations and no risks from a weakening Europeaneconomy .
Theseissues are hurting packaged-food competitors like
Proctor & Gamble (
General Mills (
, which have significant sales overseas.
Opportunities to boost profits...
Margins were eroding before, but the new Kraft is trying to
reverse this trend by allocating more resources to larger and
more profitable brands. This strategy should enable new Kraft
to capture market share and grow faster than competitors. The
breadth of Kraft's product line had led to a scatter-gun
approach to advertising, and spending that was only
two-thirds that of packaged-food peers. The new Kraft has
more resources to invest in marketing and a tactical approach
that allocates advertising dollars based onprofit margins and
momentum of each brand. This new marketing plan has already
produced 20% sales gains for Velveeta Shells & Cheese and
Kraft Mayo, and 10-11% higher sales for Capri Sun and
Philadelphia Cream Cheese. Kraft also plans to re-energize
familiar but languishing brands such as Jello, Maxwell House
Coffee and Planters Nuts through targeted ad spending.
Because of its smaller, more tightly-focused brand portfolio,
Kraft expects to deliver industry-leading productivity as
well as cost savings through specialized quality management
initiatives, supply chain simplification and strategic
sourcing. The company has already delivered four straight
quarters of top- and bottom-line growth, and predicts high
single-digit earnings-per-share growth on a consistent basis.
For every dollar of cost savings achieved, Kraft plans to
reinvest 50 cents in the business and return 50 cents to
Firm commitment to dividend
Cashwill be king, according to the newCEO W. Anthony Vernon,
and Kraft will live and die by its dividend. "This dividend
reflects our intention to deliver a significant return of
cash to shareholders through a superior dividend payout
that's targeted to grow consistently, year after year," he
recently said in a statement.
The company declared an initial quarterly dividend of 50
cents per share ($2 annualized) in December that yields 4.4%,
as stated earlier. In addition, it targets 75% dividend
payout on an ongoing basis (versus 50-60% payout for old
Kraft) and more consistent dividend growth, which will be
funded by steadily increasingfree cash flow . The new Kraft
targets free cash flow at 85% of earnings, while the old
Kraft rarely produced free cash flow above 60-70% of
Risks to Consider:
There are risks associated with Kraft's new strategy and the
company warned investors to expect flat-to-declining sales next
quarter, as it prunes less profitable brands and incurs
restructuring costs. Kraft is reportedly in the process of selling
its Breakstone dairy business and estimates $490 million of
restructuring costs, including $180 million of cash expenditures,
In addition, Kraft was debt-free before the spinoff, but had
to borrowfunds to pay aspecial dividend to Mondelez. As a result,
the new company has $9.6 billion oflong-term debt versus just
$7.5 billion of shareholders'equity . There are no debtmaturities
before June 2015.
Action to Take -->
Income investors should find plenty to like about the new Kraft. As
more focused firm, it is able to invest in the growth of its
dominating brand names, but without the lavish spending or
bureaucracy that hindered before the spinoff. In addition, Kraft
shares appear reasonably priced currently, with a price-to-earnings
(P/E ) ratio of 14, below the average P/E ratio of 18 for food
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