Tickers in this Article: KFT, PEP, DMND, HSY, SLE, GIS, UL, K, NSRGY
One of the sell-side analysts whom I follow, has made the comment before that Kraft (NYSE:KFT) has long struggled to walk and chew bubblegum at the same time. Now in the wake of the company's announcement that it will split up, it feels a little ironic that the pieces seem to be working together a little better. Although Kraft shares don't represent a huge value today, investors could see trading opportunities around the split, as institutional shareholders choose sides between the higher-growth snack business and the higher-income grocery business.

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A Solid Third Quarter
Maybe it seems strange to get excited that Kraft beat its revenue estimate by 3%, but with a company of this size, where sales data is available on a monthly, or weekly basis, there usually isn't all that much wiggle room. All the same, Kraft reported that revenue rose almost 12% with organic growth of over 8%. Overseas markets are driving good growth as well, as North American revenue was up just a bit more than 4%. One interesting note is that Kraft posted over 1% growth in volume and 7% growth in prices, suggesting that customers are finally accepting higher prices and sticking with brands they like, despite the hikes.

Profitability wasn't too bad; gross margin fell one and a half points, due in part to input cost inflation, but also currency moves. The company recouped this through operating items; EBITDA growth matched reported sales growth and reported operating income grew nearly 12%, with adjusted operating income up about a half-point more. (For related reading on EBITDA, see EBITDA: Challenging The Calculation.)

Sussing out the Split
Although Kraft reports results from several operating lines, investors should remember that there will be some "mixing and matching," as the company splits. In other words, the growth of what is to be the Snacks company, was almost certainly higher than the reported 5%, while the grocery business probably wasn't quite as strong as the reported 7%.

Once it's independent, the snacks business is probably going to be a high-single-digit revenue growth company, with upwards of one-third of its revenue coming from faster-growing emerging markets. It will be interesting to see whether independence makes the company more nimble, when competing with PepsiCo (NYSE:PEP), Nestle (Nasdaq:NSRGY), Kellogg (NYSE:K) and so on. Likewise, does it make a company like Diamond Foods (Nasdaq:DMND, Snyder's-Lance (Nasdaq:LNCE) or even Hershey (NYSE:HSY), a target down the road?

By comparison, the grocery business will be a slow-growing, consistent cash flow engine. Even though Kraft has serious competitors in lunch meat, dry dinners and condiments like mayonnaise, from the likes of Sara Lee (NYSE:SLE), Smithfield (NYSE:SFD), General Mills (NYSE:GIS) and Unilever (NYSE:UL), market leadership counts for a lot. In other words, people are slow to leave brands they like and this grocery business could possibly produce tobacco-like consistency and income.

The Bottom Line
Kraft stock has done reasonably well since the split announcement, and it's only somewhat underpriced. At the same time, I cannot completely shake the worry that this split is not so much about building value, as it is about giving the impression that management is "doing something" and hiding some of the strategic missteps management has made. Whatever my feelings, it's still going to happen and investors will need to decide whether they want to own one or both businesses. Although the snacks business has a real chance to grab growth in emerging markets, don't sleep on the income potential of the grocery business's leading market slots. (For related reading, see How Grocery Price Matching Can Save You Money.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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