Kraft's Search for a High-Energy Diet


By Brian Grow When Kraft Foods announces the launch at the Consumer Analysts Group of New York conference on Feb. 18 of a "next generation" coffeemaker that uses high-margin coffee packets, Chief Executive Roger Deromedi is hoping the news will give his outfit's stock price a caffeine-like jolt. Trouble is, most analysts are already dismissing the expected announcement as nothing new. Several Kraft (KFT) competitors -- Chicago-based Sara Lee (SLE) and Procter & Gamble (PG) -- already sell or are poised to launch similar coffee machines. Kraft is the "last to market," says Christine McCracken, food and agribusiness analyst at FTN Midwest Research in Los Angeles.

Kraft's stock price has been hurt by a lumbering approach to product innovation, delays in introducing low-carb fare, and by the challenges it has encountered combating private-label competition. So far, investors haven't been particularly impressed by an executive-suite shakeup that made Deromedi the solo CEO last December, a new global organizational structure announced in January, nor by plans to cut 6,000 jobs and close 20 plants worldwide over the next three years. Kraft's stock, which went public at $31 per share in June, 2001, soared as high as $43.95 in June, 2002. It now trades at about $33, up just 2.5% since Deromedi announced Kraft's makeover last month.

SLIM PICKINGS. Since the Northfield (Ill.) maker of Velveeta cheese, Maxwell House coffee, and Oscar Mayer cold cuts is widely viewed as an established company in a mature food industry, many Wall Street analysts believe the restructuring premium Kraft executives yearn for is already built into the stock price. And despite some "hallelujah" product launches over the last decade, such as Lunchables ready-to-eat meals and DiGiorno pizzas, Kraft's cupboard appears relatively bare. With its stock selling for about 16.6 times projected 2004 earnings, vs. 16.4 on average for other food outfits, Goldman Sachs analyst Romitha Mally doesn't expect to see Kraft trading much higher than $34 a share over the next year.

Kraft also has a host of other hurdles to overcome, analysts say, making many see a return to steady earnings growth before 2005 as unlikely. "There's no quick fix at Kraft," says Morgan Stanley food-industry analyst David Adelman. Indeed, the surging popularity of the Atkins diet and low-carb foods -- forces changing consumer tastes and their definitions of health and wellness -- has Kraft scrambling to keep up. Rivals like General Mills (GIS) and Kellogg (K) launched 136 new low-carb products through November last year, Adelman estimates, adding that carb-conscious consumers represent about 30% of the U.S. population.

Yet the number of new low-carb foods that Kraft introduced in 2003 was zero. The company says it plans to stress the low-carb content of existing brands such as Oscar Mayer cold cuts and Planter's nuts this year in its ads, and it also may launch several new low-carb offerings. Trouble is, analysts say, Kraft may already be missing out on big sales-growth opportunities in an increasingly crowded low-carb segment.

"DARWINIAN APPROACH." Meanwhile, higher commodity costs, fast-growing private-label brands, and pricing pressure driven by Wal-Mart Stores (WMT) took a big bite out of Kraft's fourth-quarter profits, released on Jan. 27, which fell 7%, to $869 million. During the quarter, Kraft stemmed the tide of market-share declines in its main food categories: cheese, cold cuts, coffee, and crackers. But its struggling cookie division, including Oreos, lost an additional 1% market share due to some mistimed price increases.

Overall, profits rose a disappointing 2.4%, to $3.5 billion, in 2003, on sales of $31 billion. "We're still searching for the allure in owning this stock," A.G. Edwards & Sons analyst Christopher Growe wrote in a note to investors on Jan. 28.

Kraft's top brass is betting that "a more Darwinian approach to its business," as Growe sees it, will return some luster to the stock in the long run. Acknowledging that previous earnings targets were too bold for a low-growth industry, Deromedi cut Kraft's profit-growth estimates to between 6% and 9% per year, down from 8% to 10%, a move he hailed as the core of a "sustainable growth plan."

COOKING OVERSEAS. To improve margins and generate cost savings of $400 million by 2006, Kraft will take a $1.2 billion charge over the next three years in order to lop 6% of its workforce. This will see the shedding of some 1,300 salaried posts in the U.S. and the effective closure of the outfit's Rye Brook (N.Y.) international headquarters.

While layoffs are likely to hurt morale, Deromedi's aggressive cost-cutting has some analysts feeling grudgingly optimistic. John McMillin, food analyst at Prudential Securities, believes that some good could come out of all the bad news at Kraft, thanks to its global scale, which is unmatched by any food company except Nestlè. By melding what were virtually two separate companies -- Kraft Foods North America and Kraft Foods International -- into one global organization, Kraft can push growth more seamlessly in domestic and international markets, especially developing ones such as China, Russia, and Brazil. Kraft's sales in international markets grew 10.5% last year, vs. 2% in North America.

In addition, leveraging former co-CEO Betsy Holden's brand savvy as new chief marketing officer and adding as much as $600 million in new marketing spending this year -- most of it allocated to media advertising -- may boost the value of Kraft's vaunted brand portfolio and make its products more competitive with private labels. Lower, long-term volume growth goals -- reduced to 2% to 3% from 3% to 4% -- plus plans for some small acquisitions, may create solid buying opportunities for investors, if earnings improve in the first half of 2004. It's a turnaround playbook that follows the model of P&G's successful restructuring, argues McMillin, who notes that P&G earnings rose 22%, to $1.8 billion, in its fiscal second quarter ending Dec. 31, 2003.

TWEAKING OLD FAVORITES. In the short term, Deromedi and his team face a tough turnaround task, one made more daunting by lingering expectations of a Kraft spin-off by parent company, Altria Group (formerly Philip Morris, MO), which owns 84% of Kraft. During the Jan. 27 analysts meeting to announce Kraft's restructuring plan, Altria Chief Executive Louis Camilleri, who also serves as Kraft's chairman, was a looming presence. Analysts report seeing Camilleri watching Deromedi's performance quietly from the wings. An announcement of a Kraft spin-off could come by yearend, predicts A.G. Edwards' Growe, meaning Kraft's emergence from Altria's shadow could be complete in 2005.

Still, the biggest challenge in bringing Kraft back to life is likely to be a dearth of hot new products. Investment in research and development was flat in 2001 and 2002 at about $359 million, say analysts. And for several years, Kraft has relied heavily on the rollout of existing products into new markets or minimalist brand extensions, such Capri Sun Sport drinks and Oreo Double Delight Mint & Crème cookies that have delivered meager sales growth.

In fact, some analysts argue that Kraft should divest some underperforming brands to streamline its portfolio. While the company plans to tout yogurt-filled Newtons and the new Back to Nature line of organic cereals and granola at this week's Consumer Analyst Group of New York conference in Scottsdale, Ariz., "they really need a home run," says FTN Midwest Research's McCracken. As far as investors are concerned, it looks like it'll take more than a nifty coffee machine to put the buzz back in Kraft. Grow is a correspondent in BusinessWeek's Chicago bureau


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