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It Just Got Hotter In Kraft's Kitchen


As Kraft Foods Inc. (KFT) used to remind consumers, America spells cheese k-r-a-f-t. Lately, those letters have been spelling something else: frustration. Since Altria Group Inc. (MO) spun off a minority interest in Kraft in mid-2001, the stock price of the packaged-food giant has risen just 12.6%, lagging its peer group, the Standard & Poor's 500-stock index, and even bank certificates of deposit.

Now, the pressure on Kraft Chief Executive Irene B. Rosenfeld to provide shareholders with a tastier investment is becoming more intense. On Jan. 31, Altria said it will distribute its remaining 88.6% stake in Kraft to shareholders on Mar. 30. Altria may have been O.K. with an underachiever; if nothing else, Kraft's steadiness helped balance the uncertainties of Altria's cigarette business. But outside stockholders generally want to see quick results. Timothy G. Ewing, co-manager of a large-cap value fund at Mesirow Financial Holdings Inc. in Chicago, sold all of its 200,000 Kraft shares last fall. "We just didn't see a lot of upside in it," he says.

Rosenfeld concedes that Kraft needs to slip into a higher gear. "It's time to grow. Our investors have told us that, and I would agree with them," she says. "But this is not Extreme Makeover: Home Edition that'll get fixed in 60 minutes. We've got some fundamental work to do."

In the short term, in fact, Kraft's results may suffer. Analysts say Rosenfeld, 53, who was brought in last June from PepsiCo Inc. (PEP), where she was chief executiveof its Frito-Lay division, will have to hike outlays on marketing, R&D, and information technology to make up for inadequate spending in the past. Kraft also will have to pay 4.9% more for raw ingredients in 2007, after benefiting from a small cost decline in 2006, figures analyst Edgar Roesch of Banc of America Securities (BAC). In addition, the overnight release of nearly 1.5 billion Kraft shares is expected to swamp demand.

Higher expenses in 2007 should keep returns close to flat. David Nelson, an analyst with Credit Suisse (CS), predicts Kraft will net $3.1 billion, or $1.90 a share, in 2007 on sales of $35.1 billion. 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 5 1/2 years ago.

Kraft has a lot going for it, of course. The Northfield (Ill.) company is the nation's biggest maker of packaged foods and second worldwide only to Nestl? (NSRGY) of Switzerland. Look through the kitchens of 200 U.S. households and you'll find a Kraft product in all but one of them. Its brands include Oscar Mayer, Post, and Nabisco. A half-dozen boast sales of more than $1 billion a year, while 50 top $100 million. And the company has also had some new successes. Sales of its South Beach Diet line of products, introduced in early 2005, rose to $350 million last year, estimates analyst Roesch. Its California Pizza Kitchen frozen pizzas are selling well, too.

GETTING STALE

Problem is, other old brands like Velveeta, Maxwell House, and Jell-O are sinking. Like its rivals, Kraft has extended product lines to get the most from its blockbusters. But the strategy may be played out. The company already markets 14 varieties of Oreo cookies, for instance. How much pop, analysts ask, could a 15th possibly provide? Rosenfeld agrees: "We need to rebuild our pipeline."

Under Altria, management used acquisitions, such as the $18.9 billion takeover of Nabisco in 2000, to overcome slow internal growth. Rosenfeld says that now Kraft will be better able to use its stock, worth $57.8 billion, to make more buys. She has started unloading noncore or underperforming brands; on Jan. 23, Kraft sold its slow-growth Cream of Wheat brand for $200 million. Others sales could include Oscar Mayer, Planters nuts, and Grey Poupon mustard, say analysts.

The initial logic behind the spin-off may have been to remove any potential cloud on Kraft from Altria's tobacco business, but now Altria seems to be doing its investors a favor by unloading the rest of Kraft. It may be some time, though, before the breakup pays off for Kraft shareholders.

By Michael Arndt


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