Kraft: Time to Sink or Swim


Parent company Altria is poised to outline its plan to distribute its remaining 89% stake in the food company to shareholders

America spells cheese, Kraft Foods (KFT) used to remind consumers, K-R-A-F-T. Lately, those letters have been spelling something else: dead money. Since Altria Group (MO) spun off a minority interest in Kraft in mid-2001, the stock price of the packaged-food subsidiary has risen just 13%, lagging its peer group, the Standard & Poor's 500-stock index, and even interest-bearing checking accounts.

Now, Kraft Chief Executive Irene Rosenfeld is going to feel more heat to turn the company into at least an average investment. On Jan. 31, as it reports 2006 results, Altria is expected to detail its plans to distribute its remaining 89% stake in Kraft to shareholders. Altria may have been O.K. with an underachiever. Outside stockholders generally aren't that patient.

Rosenfeld, 53, who was brought in last June from PepsiCo (PEP), where she had been chief executive of its Frito-Lay division, may touch on her strategy for Kraft in a separate conference call with analysts on Jan. 31, when Kraft announces its results. She declined to comment before then. But given Rosenfeld's long history at Kraft—she began in market research in 1981 and stayed on into 2004—industry analysts foresee no dramatic change for the company or its stock.

Stuck in the Slow Lane

Indeed, Kraft's share price may fall further, warns David Nelson, a food industry analyst with Credit Suisse (CS). Previewing Kraft's 2006 report, Nelson says Rosenfeld will have to hike spending on marketing, research and development, and information technology to make up for inadequate spending in the past. In the short term, that would mean lower profits. Nelson predicts Kraft will net $1.90 a share, or $3.1 billion, in 2007. It earned $1.92 a share in 2006, or $3.15 billion, he estimates, and $1.88 in 2005 before one-time items.

Kraft stock closed at $35.17 on Jan. 30. Nelson's target price for Kraft stock over the next 12 months: $31 a share, the same price it opened at in its initial public offering five and a half years ago.

Analyst Edgar Roesch of Banc of America Securities (BAC) has soured on Kraft, too. Trimming his earnings forecast, he downgraded the stock to neutral from overweight on Jan. 4. In addition to facing increased outlays on marketing and R&D, Roesch says, Kraft will have to pay 4.9% more for raw ingredients in 2007, another squeeze on margins.

Stagnant Brands

Kraft has a lot going for it, of course. The Northfield (Ill.) company is the nation's biggest maker of packaged foods, with estimated revenue of $34.1 billion in 2006. Worldwide, in fact, only Nestlé (NSRGY) of Vevey, Switzerland, is larger. Kraft's brands include Oscar Mayer, Oreo, Post, Maxwell House, Jello, Nabisco, DiGiorno, and Velveeta. A half-dozen brands boast sales of more than $1 billion a year, while 50 top $100 million.

Look through the kitchens of 200 U.S. households, and you'll find a Kraft product in all but one of them.

Problem is the brands are no longer growing. As a result, neither is the company. Kraft's revenue was flat in 2006. While net income rose last year from $2.6 billion in 2005 and 2004, Kraft still made more money in both 2002 and 2003.

Acquisition Speculation

Under Altria, or Philip Morris, as it had been known, management used acquisitions to overcome slow internal growth. It bought Kraft in 1988 for $13 billion and then merged it with General Foods, which Philip Morris purchased in 1985. It repeated the move in 2000 with its $18.9 billion takeover of Nabisco.

Rosenfeld, Kraft's third CEO since 2003, is scheduled to unveil her plans at a consumer-products industry conference in late Feburary. She could stay the course. Analysts have long speculated Kraft might bid for France's Groupe Danone (DA). Kraft has plenty of currency in its stock, which is worth $57.6 billion. The downside: A premium-priced takeover would depress earnings per share at least initially and add to its debt load.

But reviving its existing products would be harder and could cost even more. Like other big food companies, Kraft has extended product lines to get the most from its blockbuster brands. This strategy may be played out, however. The 94,000-employee company already markets 14 varieties of Oreo cookies, for instance. How much pop could a 15th possibly provide?

Marketing Spending Laggard

Analysts warn of other troubles. Nelson points out that Kraft spends 4.1% of sales on marketing, significantly below the industry average of 5.7%. Likewise, the company invests just 1.1% of revenue on R&D, which could explain why product introductions have slowed and why most of them haven't bowled over consumers. Nelson also notes that Kraft probably must hike its investment in information technology to mesh the various systems it's bolted on through acquisitions.

Kraft has done some things right. Sales of its South Beach Diet line of products, introduced in early 2005, rose to $350 million last year, estimates analyst Roesch. Microwavable pizzas are selling well, too. On Jan. 23, Kraft also sold its slow-growth Cream of Wheat brand for $200 million to B&G Foods (BGF), though a charge from that sale will lower 2007 earnings by 1¢ a share.

In addition, other tortoises have morphed into hares. ConAgra Foods' (CAG) share price has zoomed 38%, to $26 on Jan. 30 from $18.85 last March after new CEO Gary Rodkin beat analyst earnings forecasts with a turnaround strategy that focuses the Omaha company on a few giant brands, such as Healthy Choice, while closing about a dozen plants.

Long Wait for a Payoff?

But more than any other company, Kraft embodies processed food. That worked to its advantage when consumers chose the convenience of packaged products over making meals from scratch with fresh ingredients. Now, though, consumers are turning to organic foods that seem healthier. "Organic Kraft," writes Nelson in a Jan. 24 note to investors, "sounds like a contradiction in terms."

Altria seems to be doing its investors a favor by unloading the rest of Kraft, leaving the parent company with its tobacco business and a 28.7% interest in another former subsidiary, brewer SABMiller (SBMRY). But it may be some time before the breakup pays off for Kraft shareholders.


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