Coffee Concerns Heat Up, Kraft Can Cool the Fire with Flavored Water

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Kraft Foods ( KFT ) has done well to sustain demand in the face of higher coffee prices brought on by rising commodity prices. Kraft is the world's second largest food and beverage company after competitor Nestlé ( NSRGY ). It also competes with PepsiCo ( PEP ), General Mills ( GIS ) and Kellogg ( K ).

Kraft manufactures both food and beverages, with beverages accounting for nearly 14% of our $32.58 price estimate for Kraft's stock , which reflects a small premium to market price. Chocolate, candy & gum constitute around 31% of our price estimate, with snacks adding 19% and grocery products representing another 14%.

Coffee Prices Heating Up

Coffee prices have trended upwards over last year. Though demand for coffee has remained strong, supply shortages have emerged due to low production levels from major producers across the globe. Large coffee producers like Brazil, Columbia and Mexico have had to deal with unfavorable weather conditions leading to low-yielding crops. With low inventory levels, coffee prices are expected to increase further through 2011.

Flavored Water Could Cool Concerns

Given the ongoing rise of coffee prices, Kraft may be compelled to raise prices on its products, a move that could push consumers towards lower-priced brands. However, an upcoming product release could spur new demand for Kraft beverages, and offset declining near-term demand for its coffee products.

Kraft is looking to penetrate the $1 billion flavored water market, with the rollout of its MiO line this month. The zero calorie drink will be available in six flavors and priced at $3.99. Kraft has already composed a pilot survey on the product, sending MiO samples to 100,000 Facebook users. Given the positive feedback from the survey, Kraft is hopeful that the MiO line can become the "next big thing".

Kraft can also leverage its marketing strength and wide distribution channels to overcome smaller competitors like Capella and Yum Drops, bolstering its profitability in the flavored water category.

See our full analysis and $32.58 price estimate for Kraft

Kraft's Beverage Market Share Outlook

Kraft's share of the global beverage market increased slightly between 2006 and 2008, from 13% to roughly 15%. The growth can be attributed to a change in consumer taste away from high calorie carbonated drinks and towards healthy and nutritious juice drinks. However, shifting consumer patterns brought on by the recent economic downturn shook Kraft's market share in this space back down below 14%.

Going forward, we anticipate only slight recovery in Kraft's global beverage market share to just above 14% by the end of our forecast period. But Kraft's recent push in the flavored water market could spark the growth engine and further accelerate upside from this segment.

Should Kraft also succeed in sustaining demand for its coffee products, our $32.58 price estimate for Kraft's stock could prove conservative. If Kraft can generated an added lift of 200 basis points to our beverage market share forecasts, it would imply 4% upside to our price estimate. Our $32.58 price estimate currently stands at a slight premium to market price.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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