We have initiated coverage on Kraft Foods Group, Inc. (KRFT) with a Neutral recommendation and a target price of $48.00. Headquartered in Northfield, IL, Kraft Foods Group was spun off from Kraft Foods, Inc into a separate independent company on October 1. Kraft Foods Group consists of the North American grocery business of the old Kraft Foods. The old Kraft Foods has been renamed to Mondelez International, Inc. (MDLZ) and now comprises only its global snacks business.
Kraft Foods Group is one of the largest consumer packaged food and beverage companies in North America. Its sells branded products in beverages, cheese, coffee, refrigerated meals and grocery categories, mainly across U.S. and Canada. A dozen of its brands are more than 100 years old, ten of which generate revenues in excess of $500 million. These include Maxwell House coffees; Philadelphia cream cheeses; Kraft cheeses, dinners and dressings; Oscar Mayer meats and many more.
Kraft is trying to improve its long-term results by focusing on cost savings, brand support via strong advertising, and cash generation.
Management's strategy is to re-invest half of its savings on brand building and innovation and return the other half to shareholders in the form of dividends. The company is refreshing brand portfolio through product innovation, creating new sub categories (for example it created the liquid concentrate category with its Mio water enhancer) and also remodeling products according to the demand of the untapped growth segments (like the Hispanic population in North America).
Further, Kraft aims to differentiate its brands through investment in quality upgrades of brands, promotions and marketing investments. These brand building and advertising investments are winning customers for the company around the world and simultaneously driving revenue and profits higher. These initiatives have enabled Kraft to enjoy more pricing power and improve product positioning against lower-priced private label brands. The company has been able to successfully incorporate price increases despite rising commodity costs and advertising spends, while also maintaining positive volume growth and gaining market share.
Kraft is aggressively reducing costs and improving efficiencies under its 2012-14 restructuring program. As part of this program, the company is reducing overhead expenses, managing labor costs, outsourcing distribution, reducing IT spends, simplifying the supply chain and increasing capacity utilization. Moreover, the company is undergoing a firm-wide culture change and re-aligning compensation plans. Management is targeting net productivity savings of 2.5% annually from its efforts that will provide more cash to invest in its brand building, innovation and marketing initiatives and also pay back to shareholders.
Further, Kraft aims to generate significant cash and is targeting to "put dollars in shareholders' pockets, not margins. The free cash flow of this company will be used mainly to pay steady and incremental dividends that are targeted to grow consistently in the mid-single digit range.
Despite the positives, challenging industry conditions, rising commodity inflation and a lack of exposure outside U.S. keep us on the sidelines. Though food and beverage is one of the most attractive and largely profitable markets in the world, it is also the most challenging and has seen sluggish growth and slowdown in consumption over the last few quarters. Further, Kraft's business is squarely focused on North America. Thus, unlike some of its peers, Kraft lacks exposure to the growth prospects of some fast growing emerging markets to offset headwinds from weak developed markets. Moreover, Kraft's commodity costs, on average have increased by over 35% in the past five years versus the prior five. The commodity cost volatility and higher cost environment are expected to continue over the remainder of the year.