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Kraft Foods Inc.'s ( ) second quarter adjusted earnings of 68 cents per share (excluding integration, spin-off and restructuring charges) beat the Zacks Consensus Estimate by 2 cents and the prior-year quarter’s earnings by 6 cents per share. The top-line performance was weak during the quarter. However, pricing and productivity gains offset the impact from top-line’s weak performance and eventually led the packaged food maker’s second quarter earnings higher.
Revenues and Margins
Revenues in the quarter declined 4.3% to $13.3 billion, missing the Zacks Consensus Revenue Estimate of $14.08 billion. Foreign currency fluctuations against a strong dollar is pulling down revenues of most of the companies that have significant business outside U.S. Kraft Foods is no exception with this regard, and this headwind primarily dragged the revenues down. Lower volumes due to an early Easter and difficult year-over-year comparisons due to accounting calendar changes in the prior year also hurt the top line. Organically, revenues were up 3.4%, driven mainly by pricing gain and strong performance of the power brands.
Pricing, in response to higher input costs, added 4.0 percentage points to top-line growth. Volume/mix and currency pulled down revenues by 0.6 percentage points and 5 percentage points respectively. The shift of Easter-related shipments into the first quarter and product pruning in North America hurt volumes in the second quarter. Kraft’s 21 Power Brands grew 6% in the second quarter.
Adjusted operating income improved 8.3% to $2.1 billion in the quarter despite the revenue shortfall, driven by pricing and productivity benefits. Adjusted operating margin expanded 180 basis points to 15.8%.
North America: Revenue increased 1.2% to $6.4 billion. Organically revenues increased 1.7% driven by higher pricing and power brand growth. The 15 Power brands in North America grew more than 5%. Volume/mix was however down 2.0% due to headwinds from the Easter shift product pruning.
Adjusted segment operating income increased 9% in the quarter driven by higher pricing, productivity gains and reduced overheads which offset volume/mix and input cost headwinds.
Europe: Revenues declined 14.8% in the second quarter to $3.0 billion, pulled down largely by currency impact and accounting calendar changes. However, organic revenues were up 1.4% despite volatile market conditions, mainly helped by pricing actions, which added 2.5 percentage points to top-line growth. Volume/mix declined 1.1 percentage points mainly due to the Easter shift. The 15 Power Brands grew 3% in the quarter.
Adjusted segment operating income (excluding currency and accounting calendar changes) was up in mid single digits despite the revenue shortfall on the back of productivity benefits and overhead leverage.
Developing Markets: Revenues declined 3.6% to $3.9 billion. It were yet again the currency fluctuations and accounting calendar changes that affected these revenues. Organic revenue however increased 7.6% in the quarter, helped both by pricing (added 5.7%) and volume (added 1.9%) gains. The 10 Power Brands in the developing markets grew more than 8%.
Adjusted segment operating income (excluding currency impact and accounting calendar changes) grew in high single digits in the reported quarter, driven by positive volume/mix and cost management
Kraft reaffirmed its constant currency revenue and earnings guidance. Kraft Foods expects organic revenue to grow approximately 5% in 2012, including a negative impact of up to 1 percentage point from product pruning in North America. The guidance assumes a diminishing impact from pricing in the second half.
Kraft expects 2012 operating earnings to increase to at least the lower end of its long-term guidance of 9-11% (constant currency). Benefits from cost control and Cadbury integration synergies will be partially offset by a higher effective tax rate (approximately 28%) and a 4 percentage point headwind from pension costs.
Spin-Off on Track
Kraft Foods is in the process of separating into two independent public companies: a global snacks company and a North American grocery company. Global snacks will consist of the current Kraft Foods Europe and Developing Markets units as well as the North American snacks and confectionery businesses. The North American grocery business, to be spun-off from the current company, would consist of the current US Beverages, Cheese, Convenient Meals and Grocery segments and the non-snack categories in Canada and Food Service.
The North American grocery business, which includes popular brands like Oscar Mayer meat and Kraft cheese, will be an independent public company and would be called Kraft Foods Group, Inc. It will trade under the ticker name KRFT. Following the spin-off, the current Kraft Foods, Inc. will be called Mondelez International, Inc. and will market popular brands like Cadbury, Jacobs, LU, Milka, Nabisco, Oreo, Tang and Trident. It will trade under the ticker name MDLZ. The grocery business is expected to be spun off on October 1. Kraft Foods also named the board of directors of both the companies.
We currently have a Neutral recommendation on Kraft Foods. The stock carries a Zacks #4 Rank (a short-term ‘Sell’ rating).
Overall we are encouraged by Kraft Foods’ diverse brand portfolio, significant exposure to the fast growing emerging markets and continued strong momentum from the core brands (Power Brands). Further, unlike most of its peers, Kraft Foods has been delivering much better sales and profit performances in Europe despite the region’s economic challenges. Moreover, splitting the North American business is expected to allow Kraft to focus on its distinct strategic priorities and allocate resources optimally. However, we remain concerned about rising input costs and a slow economic recovery.
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