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WIKI ANALYSIS
Kraft Foods Inc. (NYSE: KFT) is the largest food and beverage company headquartered in North America and the second-largest in the world after Nestlé SA, generating $42 billion in revenue in 2008. With 90,000 employees in over 70 countries, the firm operates in two main segments: Kraft North America Commercial and Kraft International Commercial. In addition to these two geographical divisions, Kraft's products are divided into one of five categories: snacks & cereals, beverages, cheese & dairy, grocery, and convenient meals. The company's largest customer is Wal-Mart Stores (WMT), which accounted for 16% of all sales in 2006.[1]
In January 2004, the company announced a three-year restructuring program that ended in 2008. The entire program resulted in the elimination of approximately 14,000 positions and the streamlining of the company's operations. Kraft will discontinue many of its weaker products, like parts of its rice and dessert product lines, in an effort to concentrate on higher-margin, more successful items.
On September 7, 2009, Kraft made a $16.3 billion bid for the British confectionary Cadbury plc (CBY). Cadbury plc (CBY) almost immediately rejected the bid, however on January 19, the companies came to an agreement whereby Kraft purchased Cadbury plc (CBY) for $19 billion. The expanded Kraft, now with estimated annual revenues worth more than $50 billion, is now able to reach to larger economies of scale in emerging markets.[2] Additionally, the addition of Cadbury plc (CBY)'s product portfolio allows Kraft to better compete against candy makers like Hershey Foods (HSY) and Mars.
Company Overview
Headquartered in Northfield, Illinois, Kraft Foods Inc. began in 1903 as a cheese manufacturer. The company is now the largest North America-based food and beverage company and the second largest in the world after Nestlé SA. From 1988 to March of 2007, tobacco giant Phillip Morris Company, now Altria Group (MO), owned and grew Kraft Foods, merging the food company with Nabisco and General Foods. Altria Group (MO) took Kraft public in 2001, maintaining an 88.1% stake in the stock until the completion of the spin off in 2007.
Quarterly Earnings
Q1 2009
In the first quarter of 2009, Kraft posted revenues of $9.4 billion, a 6.5% decrease from Q1 2008 figures; net income increased 10.2% to $660 million.[3] Unfavorable currency fluctuations decreased revenues by 7.9% during the quarter due primarily to the strength of the U.S. dollar against the euro, Canadian dollar, Brazilian real, Russian ruble and British pound.[3] The company did benefit from higher net pricing which increased revenues by 5.7%, however, this also contributed to a decrease in volume which lowered revenues by 3.4%. The increase in net income is a result of Kraft's ability to maintain costs and operating expenses as prices increased, contributing to a higher margin.[3]
Q2 2009
In the second quarter of 2009, Kraft posted revenues of $10.2 billion, a 5.9% decrease from year prior figures; net income increased 11% to $827 million.[4] Like most multinational, American based food companies, Kraft suffered from adverse currency shifts which decreased revenues by 8.1% during the quarter. This decrease was augmented from divestiture charges as a result of Kraft's split-off of it's Post cereal unit. These decreases were countered by .2% increase in volume as well as a 3.1% increase in net pricing across the company's units.[4] Kraft continued to benefit from company wide cost decreases as a result of its restructuring program which ended in 2008. All of Kraft's US segments enjoyed moderate growth during the quarter, save its cheese unit which was forced to cut prices as a result of decreases in the prices of its Dairy inputs. Its international units all suffered from sluggish growth, which only augmented trouble caused by the weakening of the US dollar. Net income growth was mostly the result of the elimination of costs relating to the company's restructuring plan and lower losses on divestitures. Ignoring these charges, net income would have remained roughly unchanged from the previous year. [5]
Q3 2009
In the third quarter of 2009, Kraft Foods generated revenues of $9.8 billion, a decrease of 5.7% from the Q3 2008; net income for the quarter decreased 39.5% from the previous year.[6] However, operating income prior to taxes increased 38.7%; this is not reflected in net income because Q3 2008 included $845 million gained from the sale of Post cereals in that quarter. The strengthening US Dollar decreased net revenues by $578 million, a 5.6% decline.[7] Despite decreased total revenues in six of the company’s eight operating segments, operating income increased in all eight sectors. The largest improvements were seen in Kraft Foods Europe (increased $96 million, 83.5%), U.S. Beverages (increased $50 million, 60.2%), U.S. Convenient Meals (increased $48 million, 60.8%), and U.S. Grocery (increased $22 million, 9.3%). Nearly every sector benefited from lower raw material costs, lower manufacturing costs, and lower costs as a result of a corporate restructuring program. [8]
Segments
North America
Beverages
As a beverage manufacturer, Kraft produces primarily coffee, aseptic juice drinks, flavored water, and powdered beverages. The company's most popular brands of beverages in North America include Maxwell House coffee, Kool-Aid, and Country Time powdered beverages.
From 2005 to 2006, North American beverage sales volumes decreased 7%, primarily due to the discontinuation of certain ready-to-drink product lines and lower shipments of coffee. Net revenues were up $32 million, or 1%, due to higher pricing, increased promotional spending ($36 million), and favorable currency exchange rates ($14 million). The loss of a U.S. coffee plant contributed to a $258 million (55.7%) loss in operating income.
Cheese & Food Service
As a cheese & food service manufacturer, Kraft produces primarily natural, processed and cream cheeses. The company's popular brands within North America cheese & food service include Kraft Singles, Philadelphia cream cheese, and Velveeta.
From 2005 - 2006, volume decreased 5%, primarily due to the divestitures of Canadian grocery assets, U.S. yogurt assets, industrial coconut assets, and lower margin product lines. Net revenues decreased $166 million (2.7%), due primarily to lower net pricing and were partially offset by favorable currency. Operating companies income decreased $35 million (3.8%), due primarily to higher pre-tax charges for asset impairment and exit costs ($72 million)and higher marketing spending ($20 million).
Convenient Meals
As a convenient meals manufacturer, Kraft produces primarily frozen pizza, packaged dinners, lunch combinations and processed meats. The company's popular brands within North America Convenient Meals include DiGiorno, Kraft Macaroni & Cheese, and Oscar Mayer hot dogs.
From 2005 - 2006, volume increased 0.5%, driven by higher meat shipments (cold cuts, hot dogs and bacon) and higher shipments of pizza. This increase occurred despite competition in macaroni and cheese dinners and the divestiture of the rice brand and assets. Net revenues increased $144 million (3.1%), due primarily to higher volume ($138 million), favorable currency ($14 million) and higher pricing. In meats, higher net revenues were driven by continued strong results for new products and higher net pricing. Pizza net revenues increased due to higher shipments and favorable mix from new products. Operating income increased $121 million (15.3%), due mainly to the 2006 gain on the sale of the rice brand and assets ($226 million), lower fixed manufacturing costs ($24 million) and favorable currency ($4 million).
In early January 2010, Kraft sold its frozen pizza business to Nestle (NSRGY) for $3.7 billion, approximately 2.3 times its total sales in 2009.[9] The purchase adds the DiGiorno, Tombstone, Jack's and Delissio brands to Nestle's stable of products, as well as the license to sell California Pizza Kitchen frozen pizza. In 2009, these brands generated revenues of $1.6 billion, but the sale gave the company the extra funds necessary to increase their bid for Cadbury.[10]
Grocery
As a grocery product manufacturer, Kraft produces primarily enhancers and desserts. The company's popular brands within North America Grocery include Jell-O, Grey Poupon, and A1 steak sauce.
From 2005 - 2006, sales volume decreased 21.6%, due to the divestitures of fruit snacks and Canadian grocery assets, the discontinuation of certain Canadian condiment product lines and lower shipments of ready-to-eat and dry packaged desserts, and spoonable salad dressings. Net revenues decreased $293 million (9.7%) thanks to lower volumes. Operating income increased $195 million (26.9%), due primarily to lower pre-tax charges for asset impairment and exit costs ($206 million, including the $113 million asset impairment charge in 2005 related to the sale of the Canadian grocery assets and the $93 million asset impairment charge related to the 2005 sale of the fruit snacks assets), lower marketing, administration and research costs ($30 million), favorable currency ($8 million) and higher pricing.
Snacks & Cereals
As a snacks & cereals product manufacturer, Kraft produces primarily ready-to-eat cereals, cookies, crackers, salted snacks and Chocolate confectionery. The company's popular brands within North America Snacks & Cereals include Oreo, Planters nuts, and Ritz crackers. In November of 2007, Ralcorp Holdings, a private-label cereal maker, agreed to purchase the Post cereals division from Kraft in a deal worth $2.6 billion.
From 2005 - 2006, sales volume decreased 3.4%, thanks to the divestitures of the pet snacks brand and assets, and a small biscuit brand, and lower shipments of snack nuts. Net revenues increased $108 million (1.7%), primarily due to higher pricing, promotional spending and favorable currency ($38 million). This increase was partially offset by rising energy prices. In snack bars, net revenue increases were driven by new product introductions. Operating income decreased $101 million (10.9%), due primarily to higher pre-tax charges for asset impairment and exit costs ($138 million) related to divestitures such as the pet foods divestiture.
With the acquisition of Cadbury, Kraft now owns the second-largest market share for gum - Trident and Dentyne - and the top market share for cough drops - Halls. The new brands also have majority market shares in Canada and Latin America.
International Sales
European Union Sales
Kraft Foods sales products from each of the five major food product categories, featuring brands familiar and unfamiliar to North America. From 2005 - 2006, sales volume increased 2%, primarily due to the acquisition of the Spanish and Portuguese operations of United Biscuits ("UB"). Net revenues decreased $42 million (0.6%), mostly thanks to unfavorable currency ($93 million) and the divestiture of the U.K. desserts business. Operating income decreased $174 million (24.1%), due primarily to higher pre-tax charges for asset impairment and exit costs ($273 million, including $170 million of asset impairment charges related to Tassimo), increased promotional spending, higher marketing, administration and research costs. With the acquisition of Cadbury, Kraft now owns the leading gum, chocolate, and candy brands in much of the EU. Its candy and gum brands are sold throughout the continent, but it also has significant presence in the chocolate markets of Poland, Russia, and France.
Developing Markets, Oceania, & North Asia Sales
The Developing Markets, Oceania & North Asia segment manufactures and sales many of the popular North American brands across each product category as well as some foreign brands. From 2005 - 2006, volume decreased 0.9%, mostly due to lower sales volume in Asia Pacific, contrary to higher volumes in Eastern Europe and Latin America. Net revenues increased $460 million (11.2%), due in part to higher pricing ($178 million) and favorable currency ($85 million). Operating income increased $16 million (4.0%), due to higher pricing, lower costs, and favorable currency ($16 million), partially offset by higher marketing, administration, fixed manufacturing and research costs. With the addition of Cadbury's brands, Kraft now has majority market shares in Australia, New Zealand, India, Thailand, and Malaysia for chocolate, gum, and/or candy.
Kraft's strategy in developing markets is based around focusing on ten "power brands" in ten countries. Tang, Oreos, and Jacobs Coffee are some of the brands that have allowed developing markets to account for 21% of Kraft's total revenues.[11] Tang sales increased 30% in this region last year and organic sales have increased an average of 12.9% per year since 2006.[12]
Middle East and Africa Sales
The Middle East and Africa region is a rapidly growing market for Kraft - in 3Q2008, sales grew 19.1%.[13] Higher sales volume and increased efficiency in manufacturing and transportation logistics were the main drivers of the sales growth. The company plans to continue growth by increasing investments in the region and producing more of its power brands locally. The purchase of Cadbury has given Kraft the leading share of the African confection market.
Cadbury (CBY) Acquisition
With the purchase of Cadbury (CBY) on January 19 for $19 billion, the new Kraft is expected to have annual revenues of more than $50 billion. The acquisition makes Kraft the world's largest chocolate and sugar confectioner, with a solid second place in the gum category thanks to Cadbury's Trident label.[14] Perhaps more important than the brands of Cadbury (CBY) is her geographic reach; Kraft now has inroads into many developing world markets where it formerly had no presence. In India, for example, Cadbury (CBY) has had a presence for the past 60 years, selling chocolate, snacks, dairy, and other candies.[15] The merger is also expected to affect players further down the supply chain, such as cocoa producers. It is possible that the producers may consolidate their operations in response to expected increased pressure for lower raw material prices.[16]
Trends & Forces
Detrimental Supermarket Consolidation
For the years ended December 31, 2006, 2005 and 2004, Kraft's five largest customers accounted for approximately 29%, 26% and 28%, respectively, of its net revenues, and the company's ten largest customers accounted for approximately 40%, 37% and 38%, respectively, of its net revenues. The company's largest customer, Wal-Mart Stores (WMT), accounted for approximately 15%, 14% and 14% of net revenues for 2006, 2005 and 2004, respectively. Manufacturers like Kraft Foods are becoming increasingly dependent on a small number of retailers for sales volume, which gives these retailers (i.e. Wal-Mart Stores (WMT)) significant leverage to bargain for lower prices. This can negatively impact any firm whose goods are sold in supermarkets.
Increasing Raw Materials Prices Hurt Earnings
The company uses hedging techniques to minimize the impact of price fluctuations in its principal raw materials; however, such techniques do not completely protect Kraft Foods. Kraft is a major purchaser of milk, cheese, plastic, nuts, green coffee beans, cocoa, corn products, wheat, pork, poultry, beef, vegetable oil, sugar, other sweeteners and numerous other commodities. Kraft's commodities expenses are expected to rise $2 billion, or 13%, in 2008.[17] If the company is unable to increase its prices to offset increased cost of commodities due to consumer sensitivity, Kraft Foods may experience lower profitability. Raw materials prices to watch are:
Strengthening Dollar Benefits Earnings
Product sales abroad represent over 33%, or more than $11 billion, of Kraft's total revenue. With more than 1/3 of its business conducted in a different currency and financial data reported in U.S. dollars, the company's performance fluctuates with changes in foreign exchange rates, especially the euro, Swiss franc, British pound and Canadian dollar. In late 2008, the dollar began to reverse it's fall and began to strengthen against world currencies. As the dollar strengthens, each sale in a foreign currency translates to fewer dollars when returned to the United States, lowering revenue. Although the dollar vs. euro relationship has the greatest impact, Kraft has operations in 72 countries and sells its products in more than 155 countries, often making the impact of exchange rate fluctuations very complicated.Product Recalls Hurt Both Reputation & Earnings
The recall of one of Kraft's products not only temporarily terminates revenue generated by that product while costs continue to run high, but in a popular enough product or on a large enough scale, the impact can spread to other products as the public loses trust in the brand. Kraft's most recent recall took place on August 8th, 2007, when the company recalled their Knudsen cottage cheese in seven states. Fortunately, Kraft told consumers not to worry: the affected cheese isn't making people sick, it just doesn't taste right.
Growth in Emerging Markets Stimulates Demand
Coca-Cola Company (KO), Pepsico (PEP), Kraft Foods and other food and beverage manufacturers have seen strong growth in emerging markets in recent years. As incomes rise, packaged food becomes more accessible for a larger percentage of the population, stimulating demand for these companies' products. Kraft's Developing Markets, Oceania & North Asia sector has scene robust growth in recent years, generating $3.6 billion in 2004, $4.1 billion in 2005, and $4.6 billion in 2006.
Rising Demand for Organic Foods Hurts Kraft
Dean Foods Company (DF), Kraft, and other companies that sell dairy products in the U.S. are being harmed by an increase in natural & organic food consumption. Dairy farmers in the U.S. commonly use artificial growth hormones to increase milk production, which is not in keeping with organic practices. Companies such as Whole Foods Market (WFMI) benefit from organic demand.==
Competitors
In 2007, Kraft Foods Inc., is the largest food and beverage company headquartered in North America and the second largest in the world after Nestlé SA. The company's principal competitors include Pepsico (PEP), General Mills (GIS) , and Nestlé SA. Kraft produces foods and beverages across a wide variety of product categories, making way for competition with many specified, smaller companies.
Kraft lags in both pre-tax margin and sales growth. Overall, the company is the second largest of its competitors, allowing it to take risks others cannot afford.
References
- ↑ KFT 2008 10-K
- ↑ Kraft and Cadbury Agree on Friendly Merger, New York Times, 1/19/2010
- ↑ 3.0 3.1 3.2 HNZ 2009 10-K
- ↑ 4.0 4.1 KFT 2009 10-Q
- ↑ KFT 2009 10-Q
- ↑ KFT Q3 2009 10-Q, p. 1
- ↑ KFT Q3 2009 10-Q, p. 25
- ↑ KFT Q3 2009 10-Q, p. 31-36
- ↑ Frozen Pizza A Sizzling Investment, Investopedia.com, 1/13/2010
- ↑ Frozen Pizza A Sizzling Investment, Investopedia.com, 1/13/2010
- ↑ Kraft's Tang Makeover Led to 30% Sales Jump Abroad Last Year, Business Week, 3/6/10
- ↑ Food Companies Look To Developing Markets to Fatten Sales, Chicago Tribune, 3/14/10
- ↑ Kraft Foods MEA Moves Ahead With Strong Third Quarter Results.
- ↑ Kraft Gets Its Sugar Fix, Motley Fool, 1/20/10
- ↑ Kraft To Have Presence in India, Bloomberg, 2/7/10
- ↑ Kraft's Cadbury Deal May Force Cocoa Consolidation, Moneynews, 2/12/10
- ↑ KFT Q3 2008 Earnings Call Transcript, Seeking Alpha
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