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Kraft Gives Post-Spinoff Outlook

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At an investor day held on September 7th, Kraft Foods Inc. outlined the financial outlook for its soon to be spun off North American grocery business. The financial targets for its international snacks business, which is to be called Mondelez, were unveiled at the Barclays Capital Back to School Consumer Conference a day before the analyst day event.

Kraft is due to spin off its North American grocery business into a separate independent company on October 1. The North American grocery business will be called Kraft Foods Group, Inc. and will trade under the ticker symbol KRFT. Following the spin off, the current Kraft Foods, Inc. will be called Mondelez International, Inc. and will focus on the global snacks business. Mondelez will trade under the ticker symbol MDLZ. The spin off is expected to be completed on October 1. Both the companies are expected to start trading regularly on the NASDAQ stock exchange from October 2.

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, which is 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.

Outlook for Kraft Foods Group

At the investor day conference, Kraft Foods highlighted that its North American Grocery Company will deliver profitable top-line and bottom-line growth, while also returning cash to shareholders in the form of dividends.

Long Term Outlook

Over the long term, organic top-line growth is expected to be in line with or higher than the North American food and beverage industry’s growth rate. Management warned that market growth rates will fluctuate due to volatility in input costs. The company is banking on innovation and brand building to achieve the targets.

Operating income growth is expected to be in the mid-single digit range and earnings growth should be in mid-to-high single digit range.

Kraft Foods aims to generate significant cash and is targeting to “put dollars in shareholders' pockets, not margins”. Free cash flow is expected to be at least 85% of the net income. The free cash flow of this company will be used mainly to pay steady, incremental dividends. The management will recommend an annual dividend of $2.00 per share to the board of directors. Dividends are expected to grow consistently in the mid-single digit range.

2013 outlook

Organic revenue for this maker of popular brands like Kraft cheeses, Oscar Mayer meat and Maxwell House coffees are expected to be in line with the long-term growth rates; i.e. equal to or above the market growth. The top-line guidance includes a negative impact of up to 1 percentage point from product pruning in North America.

Adjusted earnings (excluding restructuring charges of 26 cents per share) are expected to be $2.86 in 2013 and are expected to be driven by productivity improvement and overhead savings. Interest expense is expected to be $520 million and the effective tax rate will be 35%. The earnings are expected to be more back-half weighted with 48% to be generated in the first half and the balance in the next half.

Outlook for Mondelez

Mondelez International highlighted its 2013 and long-term outlook at the Barclays Back to School Conference. Mondelez plans to drive long-term margins higher through brand growth, overhead leverage and productivity improvements. Mondelez will market popular snacks brands like Cadbury, Jacobs, LU, Milka, Nabisco, Oreo, Tang and Trident.

Long Term Outlook

Over the long term, Mondelez is expected to deliver organic revenue growth of 5%-7%. Organic growth in Europe and North America are expected to be in the mid-single digit range, while in developing markets it is expected to be in double-digits.

Operating income is expected to increase in high single digit range at a pace faster than revenues. The growth is expected to be driven by operating expense leverage and productivity savings.  Operating earnings are thus expected to grow in a double-digit range on a constant-currency basis.

Mondelez warned that the guidance may be below expectations due to currency headwinds (due to Mondelez’s large international presence) and a higher-than-expected tax rate. Mondelez expects a mid-20% tax rate over the long term.

Unlike Kraft Foods Group, Mondelez will be reinvesting excess earnings in the business to drive long-term growth rather than paying back to investors. It will also be on the lookout for accretive acquisitions, particularly in the developing countries. The balance will go to investors in the form of share buybacks/dividends and to pay down debt. The company will pay an annual dividend of 52 cents per share.

2013 Outlook

In 2013, Mondelez expects its organic top-line to grow at the lower end of its long-term range of 5%-7%. Pricing and the challenging economic conditions are expected to lead to lower growth versus the long term targets.

Constant currency operating earnings are expected to range between $1.50 and $1.55, which includes currency headwinds of about 15 cents.

Our Recommendation

We currently have a Neutral recommendation on Kraft Foods. The stock carries a Zacks #3 Rank (a short-term ‘Hold’ rating).

We are optimistic about Kraft Foods’ diverse brand portfolio, reinvestment in core brands, focus on innovation, strong momentum of power brands and significant exposure to the fast growing emerging markets. Further, the spin-off is expected to allow Kraft to focus on its distinct strategic priorities and allocate resources optimally. With the spin-off to be completed in less than a month, we prefer to wait and see how it unlocks value.

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