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Mondelez Beats Q1 Earnings, Will Divest Coffee Biz

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In ground breaking news, Mondelez International, Inc. (MDLZ - Free Report) announced the proposed spin-off of its coffee business to Netherlands-based coffee company, D.E Master Blenders 1753 for $5 billion in cash.

Moreover, the snacking giant’s first-quarter 2014 results were better than last quarter, with the company beating the Zacks Consensus Estimate for both revenues and earnings. Also, the company announced a new restructuring plan targeting aggressive cost savings which should enable it to accelerate its margins. Shares soared around 9% in pre-market trading.

The Deals Sounds Great

The coffee portfolio of Mondelez will be merged with that of D.E Master Blenders 1753 to form a new Dutch coffee company called Jacobs Douwe Egberts (JDE). The transaction, which excludes Mondelez’s coffee business in France, is subject to regulatory and shareholder approvals and is expected to close next year. Acorn Holdings B.V. ("AHBV"), owner of D.E Master Blenders 1753, will have a majority stake in the combined company and will also hold a majority of the board seats.

The merger will bring together Mondelez’s Jacobs, Carte Noire, Tassimo and other coffee brands and D.E Master Blenders’ popular Douwe Egberts, Pilao and Senseo brands, thereby creating significant revenue synergies.

Mondelez will enjoy a 49% stake in the combined company which is expected to have annual revenues of $7 billion and EBITDA margin in high teens range.

Mondelez faced headwinds from lower coffee prices in 2013 due to pass through of lower green coffee costs which significantly hurt its top line.

The spin-off of the coffee business will allow Mondelez to concentrate on its core snacks business, thereby improving its revenues and profits. If the deal gets through, around 85% of Mondelez’s revenues will come from snacks. Moreover, cash proceeds from the deal will be used to accelerate share buybacks and lower the company’s debt, further improving earnings.

First-Quarter Earnings Beat

Mondelez’s first-quarter adjusted earnings of 39 cents per share beat the Zacks Consensus Estimate of 33 cents by 18.2%. Adjusted earnings also increased 11.4% from the prior-year quarter as higher operating margins and lower share count made up for the weak revenues. Earnings grew 17.1% on a constant currency basis. Currency hurt earnings by 2 cents.

Adjusted earnings excluded loss on debt extinguishment, restructuring costs and remeasurement of net monetary assets in Venezuela. Including these items, earnings declined 70% to 9 cents in the quarter.

Revenues Still Soft

Net revenue in the quarter decreased 1.2% year over year to $8.64 billion, slightly beating the Zacks Consensus Estimate of $8.63 billion. Currency headwinds hurt the quarter’s revenues by 3.7 percentage points (pp) as 80% of Mondelez’s sales are generated outside the U.S. Once again, global snacking category slowdown (particularly in the emerging markets), weak biscuit sales in China and lower coffee pricing hit the top line.

Organic revenues (excluding impact from acquisitions, divestures and foreign exchange) increased 2.8% driven entirely by pricing gains. Organic top-line growth was in line with the company’s expectations. Pricing increased 2.5% in the quarter as management increased pricing for most non-coffee products in the first quarter to cover higher commodity costs and currency headwinds. However, lower coffee prices continued to hurt the top line, this time by around 60 basis points (bps).

Volume mix was up 0.3% in the quarter despite increased pricing in the quarter. However, volumes were significantly weaker than the fourth quarter of 2013 due to headwinds from the shift in Easter timing.

Revenues from emerging markets were up 6.7%, better than 5.9% in the fourth quarter. Strong performance in Russia, India and Brazil were offset by weakness in China. Revenues declined in China due to economic slowdown and weak biscuits performance.

On the other hand, revenues in developed markets grew only 0.2% as growth in North America was offset by weakness in Europe and developed markets of the Asia Pacific region.

Mondelez’s Power Brands grew 4.8% in the quarter driven by brands like Tuc, Club Social, belVita and Chips Ahoy! biscuits, Cadbury Dairy Milk and Milka chocolate and Tang powdered beverage.

Operating Margins Improve

Adjusted gross margins declined 10 bps in the quarter to 37.1% as pricing gains were offset by commodity cost inflation. Adjusted operating income increased 15.8% year over year to $1.09 billion on a constant currency basis. Adjusted operating margin increased 140 bps to 12.2% in the quarter. Operating margin gains were driven by overhead reductions, productivity gains and lower advertising costs than last year.

New Restructuring Plan

In order to accelerate cost savings and improve productivity, the company announced a new $3.5 billion restructuring plan — 2014-2018 Restructuring Program. The program aims to lower operating costs through acceleration of supply chain cost reductions, layoffs, asset disposals and implementation of a zero-based budgeting system. Under the zero-based budgeting system, every line item of the budget must be approved by department managers unlike the traditional budgeting system under which only the cost variance needed to be justified.

The program is expected to generate annualized savings of at least $1.5 billion by 2018 which can be re-invested for further margin expansion. The coffee deal will also allow the company to further cut back on its supply chain and overhead costs. Thus, Mondelez now expects to grow its operating margins to 15–16% by 2016 higher that prior expectations of 14–16%. In fiscal 2013, the company earned operating margins of 12%.

2014 Top Line Outlook Lowered

Management lowered its 2014 organic top-line growth target to reflect slower global category growth. Organic top line is expected to grow in line with the category growth rate which had slowed down to approximately 3% in the last two quarters. Previously, category growth was expected to be 4%.

Emerging market choppiness lower coffee pricing and tepid growth in developed markets is clouding top-line visibility.

Management expects these headwinds to continue in the second quarter resulting in similar top-line performance to the first quarter. Moreover, even though rising coffee prices will benefit the top line in the second half, management expects revenues to improve only modestly in the period due to emerging market choppiness.

However, the profit outlook was re-affirmed. Constant currency adjusted operating income is expected to grow at a low double-digit rate in 2014. Adjusted operating margin is expected in the high 12% range for the full year, which will be slightly better than the 2013 levels. Management expects margin growth to be driven by improved efficiency, lower supply chain and overhead costs and an improved product mix. Margins are expected to improve year over year in all the quarters.

Mondelez carries a Zacks Rank #2 (Buy). Previously known as Kraft Foods, Inc., Mondelez changed the name following the spin-off of its North American grocery business into a separate independent company, Kraft Foods Group, Inc. in Oct 2012.

Mondelez joins Kraft and other food companies like Kellogg Co. (K - Free Report) and General Mills, Inc. (GIS - Free Report) which are facing top-line headwinds from category challenges.

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