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Can Kraft Be a Big Cheese Abroad?


When Aussies stroll down the aisles of their local supermarket, what catches their eyes are snacks from Unilever (UL) and Nestl? (NSRGY). Kraft Macaroni & Cheese and Oscar Mayer hot dogs, on the other hand, are hard to find and far from first choice. "They would be classified as a slow-moving line," says Terry Walters, the owner of an IGA store in Cairns, Queensland, about the classic American macaroni-and-cheese dinner. As for hot dogs: "We have the meat pie."

Kraft may be ubiquitous in U.S. grocery stores, but overseas it's a far different picture. Kraft isn't one of Walters' top five food suppliers, ranking below even H.J. Heinz Co. (HNZ), despite its ownership of Australia's famed Vegemite spread. Only 27% of its total revenues come from overseas, vs. 44% for Heinz, more than 50% for McDonald's Corp. (MCD), and more than 80% for Coca-Cola Co. (KO)

That will have to change. As Kraft embarks on a giant initial public offering, expected in mid-June, its challenge is to once again become a growth company. Widely admired for the astute management of its brand lineup, Kraft is nevertheless stuck in a slow-growth industry in the U.S. Smart marketing and methodical cost-cutting helped it boost earnings 14.1% last year, but Kraft's sales actually dipped slightly, to $26.53 billion. In fact, Kraft's annual sales have dropped 16.2% since 1994. The company took a big step toward building revenues in December with its $19.2 billion purchase of Nabisco Group Holdings Corp. (NGH-U), whose cookie and cracker brands are growing faster than Kraft's top brands.

That deal should boost Kraft's sales to an expected $35.05 billion this year. But analysts say that if Kraft is to spark long-term growth, it must do a better job of tapping foreign consumers. Kraft acknowledged as much when it announced that once the IPO is completed, Betsy D. Holden, CEO of Kraft Foods North America, will share the chief executive office with Roger K. Deromedi, a 13-year Kraft veteran who has been president and CEO of Kraft Foods International Inc. for the past two years. The company declined to comment or make top executives available to BusinessWeek, citing the quiet period before the IPO, as did parent Philip Morris Cos. (MO)

AMERICAN ICONS. The largest food company in North America by far, Kraft has dominated U.S. grocery-store shelves for decades. Its powerhouse brands are American icons: Philadelphia Cream Cheese, Oreo cookies, Tang, Jell-O, Kool-Aid, Life Savers, Planters peanuts, Lunchables prepackaged meals for kids. Its portfolio comprises a remarkable 61 brands with more than $100 million in sales last year. Supermarket consultants say it would be nearly impossible to run a U.S. grocery store without its products.

But these aren't the best of times, even for strong supermarket brands. Shopper loyalty has waned as the grocery chains' in-house brands compete for shelf space, and big brands such as Kraft's tend to be mature. Take salad dressing. Even though Kraft is the market leader, "there's Kraft, there's Wish-Bone, there's Hellmann's," says John P. Mahar, operations director at the Green Hills Farms supermarket in Syracuse, N.Y. "If we have Wish-Bone on sale, shoppers pick up Wish-Bone. They don't care. The majority of Kraft's brands are just another commodity."

TOBACCO TAINT. Boosting sales will become even more urgent once Kraft has outside shareholders to answer to. Cigarette maker Philip Morris, which has owned Kraft since 1988, is putting 16.1% of the company on the market in an offering that could raise as much as $8.4 billion. That would be the second-largest IPO on record, behind only AT&T Wireless Group's $10.5 billion stock market debut last year. Philip Morris will remain firmly in control, but its goal is to realize more of Kraft's value by distancing the business from the tobacco taint that has held Philip Morris' stock price down.

The first concern for investors might be whether Kraft's co-CEO structure can work. Deromedi, 47, and Holden, 45, who started at Kraft as an assistant product manager in 1982, will both report to Geoffrey Bible, chairman of Philip Morris. Analysts wonder how long the arrangement will last, citing a long list of prominent companies, from DaimlerChrysler to Citigroup, where co-CEO setups fizzled. "The co-CEO structure calls into question if this is truly an independent company," says Goldman, Sachs & Co. analyst Romitha S. Mally. "At the end of the day, it will be the chairman and the board, which is controlled by Philip Morris, who will be the ultimate decision-makers for Kraft."

In this case, though, the co-CEOs have well-defined management areas. Another plus: Their personalities seem to complement each other. James J. Drury, vice-chairman of Spencer Stuart, an executive-search firm in Chicago, describes Deromedi, who holds a math degree, as "more focused on problem-solving and more likely to make tough decisions in complex situations." Holden, he says, is creative, charismatic, and more people-oriented: "She's more the one to take into consideration how a business situation may impact people."

A top task for the new CEOs will be figuring out how to expand outside North America. Overseas, Kraft faces a lineup of tough global competitors--Unilever, Nestl?, Groupe Danone--that were quicker to break into fast-growing markets in Asia, Latin America, and Eastern Europe. Unilever and Nestl?, for example, each get 32% of their sales in developing countries. Western Europe, Kraft's strongest international market, is almost as saturated as the U.S. Even in Great Britain, Kraft is only the eighth-largest food company. "A truly global organization would have a quarter to one-third of their business in North America, not three-quarters," says Adrian Richardson, global consumer and retail-sector head at BT Funds Management, a large money manager in Sydney.

FORTRESS. One problem is that Kraft's strength, convenience products, don't go over well in emerging markets, where scarce shopping dollars are concentrated on necessities. Unilever, for example, sells staples in India such as rice with added protein and salt with iodine. Kraft, on the other hand, has only a tiny presence there. But Kraft plans to jump-start sales in emerging markets by introducing additional snack, beverage, cheese, and other brands in countries where it already has a presence. It also plans to enter countries where it has no operations and to make acquisitions, especially in snacks and beverages, according to its filings with the Securities & Exchange Commission. Richardson believes Kraft could make up to three significant acquisitions in the next few years to beef up its offshore operations: "If they just build, build, build [new plants], they won't meaningfully move the dial," he says. For Kraft, "the U.S. domestic base is an absolute fortress that provides a very good cash cow" with which to go shopping. "They're not too late."

Close to home, Kraft is getting a much-needed shot of adrenaline from the Nabisco purchase. Last year, Kraft's sales dipped 1%, vs. gains of 7.3% at General Mills Inc. (GIS) and 6.3% at Hershey Foods Corp. (HSY) Many older Kraft products are in aging categories with flat or declining volumes, such as cereal and traditional store-bought coffee. But with Nabisco, Kraft picked up faster-growing product lines such as Chips Ahoy! cookies and Ritz crackers that will fuel earnings growth. Overnight, Kraft moved from a 6% to a 20% market share in crackers and cookies, a category that's expanding at more than twice the rate of the food-industry average. Goldman's Mally expects Kraft sales to rise 3.5% in each of the next three years, just ahead of the industry average. And with the cost savings it expects to squeeze from Nabisco, Kraft estimates that its earnings will grow at an above-average 18% to 22% annually over the same period.

That additional growth will be needed to cover the cost of the Nabisco deal. The newly public Kraft will carry an $18.5 billion debt load, even after using the offering proceeds to pay off a portion of the $11 billion it borrowed through Philip Morris to buy Nabisco. Nest year, $7 billion of this debt comes due, and Kraft won't be able to meet that payment, according to its prospectus. But it says it plans to use its good credit rating to refinance.

Kraft has long been a leader in product development--in 1989 it launched the novel Lunchables line that's now a $750 million-a-year product. Innovations like that put Kraft on top of the U.S. food industry. Now investors will be counting on Deromedi and Holden to sprinkle some of that magic overseas. By Julie Forster in Chicago, with Becky Gaylord in Sydney


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