Kraft In-Line, Provides Outlook

Zacks

Kraft Foods Inc. (KFT) posted fourth-quarter 2011 operating EPS of 57 cents per share, which was in-line with the Zacks Consensus Estimate. However, it went up 23.9% from 47 cents reported in the prior-year quarter.

In fiscal year 2011, Kraft delivered operating EPS of $2.29 per share, in-line with the Zacks Consensus Estimate, while beating the year-ago period by 13.4%.

The results of fourth quarter 2011 exclude the integration program costs of 8 cents per share and spin-off costs of 2 cents per share, while the fiscal 2011 earnings exclude the integration program costs of 28 cents per share and spin-off costs of 2 cents per share. The fourth quarter of 2010 also excludes the integration program costs of 15 cents per share, while the fiscal year 2010 excludes gain from discontinuing operations of 95 cents, acquisition-related expenses and costs of 21 cents, integration program costs of 29 cents and other health care legislation impact of 8 cents per share.

Including the one-time charges, reported earnings were 47 cents per share in the fourth quarter 2011, up 51.6%. However, reported earnings declined 16.7% to $1.99 per share in fiscal 2011.

Management credited the robust sales growth, effective cost management and prudent investments in the company’s iconic brands for strong results in the quarter. Kraft also remained in-line with its long-term growth targets.

Following the strong results, Kraft expects its 2012 operating earnings to grow at least 9%, despite a higher effective tax rate and a 4 percentage point headwind from higher pension costs.

Revenues and Margins

Revenues in the quarter soared 6.6% to $14.7 billion, while organic growth was 6.1%. In fiscal 2011, revenues increased 10.5% to $54.4 billion, while organic growth was 6.6% driven by strong top-line growth in all regions. Pricing accounted for 6.0 percentage points of growth and volume and mix contributed 0.6 percentage points. The Zacks Consensus Revenue Estimate was $14.8 billion for the fourth-quarter, while it was $54.3 billion for the fiscal 2011 period.

Excluding acquisition-related integration program costs and spin-off costs, underlying operating income surged 7.4% to $1.7 billion in the fourth quarter. It grew 9.7% to $7.2 billion in fiscal 2011, driven by effective input cost management, favorable foreign currency and volume/mix growth. However, these were partially offset by unrealized gains/losses from hedging activities and the negative impacts from the Starbucks CPG business, a unit of Starbucks Corporation (SBUX).

Underlying operating margin was 11.6% in the fourth quarter, while it was 13.3% in the fiscal year of 2011.

Kraft also expects its organic revenue guidance for 2012 to grow approximately 5%, including a negative impact of up to one percentage point from product pruning in North America.

Region-wise Details

North America: Revenue surged 8.9% in the fourth-quarter, while 5.1% in the fiscal 2011. Organic revenue bolstered 7.0% and 4.8% in the quarter and the full-year of 2011, respectively. Higher pricing across each business segment and significant contributions from new products fueled the growth.

Segment operating income increased 12.7% in the reported quarter, while it grew 3.6% in fiscal 2011, on the back of continued focus on cost management.

Europe: Revenues climbed 7.5% in the fourth-quarter, while 14.9% in the fiscal 2011. Organic revenue increased 3.1% and 4.6% in the quarter and the full-year of 2011, respectively. Positive volume/mix contributed to the increase. Power brands also fueled the growth by more than 7%.

Segment operating income increased 1.2% in the reported quarter, while it grew 26.1% in fiscal 2011, on the back of continued investment behind Power brands.

Developing Markets: Revenues delivered strong growth despite volatile market conditions, with a rise of 2.4% in the fourth-quarter, while 16.2% in the fiscal 2011. Organic revenue increased 7.2% and 11.2% in the quarter and the full-year of 2011, respectively. Higher pricing and positive volume/mix contributed to the increase. Power brands also fueled the growth by approximately 17%.

Segment operating income increased 30.8% in the reported quarter, while it grew 30.2% in fiscal 2011.

Other Financial Details

At the end of December 31, 2011, Kraft had $4.5 billion of operating cash flows compared with $3.7 billion at the prior year end. Free cash flow at the end of the year decreased to $3.24 billion from 3.26 billion generated at the end of December 31, 2010.

Kraft’s plan to spin off its North American grocery business to its shareholders and split itself into two independent public companies is on track. It will split into a high-growth global snacks business with estimated revenue of approximately $32 billion and a high-margin North American grocery business with estimated revenue of approximately $16 billion, by the end of 2012.

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 would consist of the current U.S. Beverages, Cheese, Convenient Meals and Grocery segments and the non-snack categories in Canada and Food Service.

Kraft expects that it will incur one-time restructuring, transition and transaction costs of $1.6 billion to $1.8 billion as it prepares to separate into two companies.  In addition, the company estimates that it may incur between $400 million and $800 million of potential debt breakage and financing fees as it executes a migration of debt to the North American grocery company.

The Way Forward

The company continues to make tangible progress in cost management, primarily driving negative overhead growth to cut costs and improve effectiveness.

Further, we are encouraged by the company’s recently strengthened business model by increasing investments in promotion and marketing that increased its pricing power and improved product positioning. These initiatives are paying off now, and margins are improving.

However, higher commodity costs, increased marketing expenses, competition from private labels and presence of tough competitors like Unilever Plc. (UL) and ConAgra Foods Inc. (CAG) concern us.

Currently, we prefer to rate the stock as Neutral. Further, Kraft Foods holds the Zacks #3 Rank, which translates into a short-term Hold rating.

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