Kraft Foods Inc. (Report #847646001)

Kraft Foods Inc. (Ticker: KFT, Last Price $33.52 as of 12/26 close)


Author: Royod

Position: Choose not to purchase

Submitted: December 27, 2007 (during market)

It Ain’t Easy Being Cheesy!

Kraft is quite possibly the most boring large cap stock going. The fine purveyor of all things cheese as well as various other food staples holds a commanding market position in many of its products. Yet still has little in the way of pricing power and is mostly a slave to changing input prices. The company has a stated desire to retool, focusing on higher margin products. This sounds fine and good, but its unknown whether they’ll be able to pull it off. Other than divestures or acquisitions, there is no reason to expect sales to either grow or decline rapidly, because everybody’s gotta eat. So given the slow growth, uninteresting dividend yield (around 3%), and unexciting margins, you’ve got to wonder why this stock should trade at 18x forward earnings.

Look, companies like Kraft are what they are. They buy inputs at x, process and combine, then sell a finished good for y. They introduce new products and retire old ones, but they are in a highly price competitive market: consumer groceries. They will therefore forever struggle to generate impressive top-line growth. Some years they hit, some years they don’t.

The following table is from Merrill Lynch, and shows sales growth by unit. The range of year-over-year change was between +11% and -9%. Note also that the overall sales increase was a meager 2%, and was due entirely to changes in pricing. There was no net increase in volume.


For me, that’s not a story for which I’m willing to pay 18x forward earnings. Here is the history of Kraft’s P/E ratio from 2003 to today. I start in 2003 to eliminate noise from the 2000-2002 bear market.
Given that the current P/E is right on the average of the last several years, at best Kraft is fairly valued. In fact, I’d argue that Kraft has been the beneficiary of portfolio managers rotating out of financial shares and into companies like Kraft. If the situation in financials gets worse, there could be an overall re-rating of valuation ratios lower generally. If the financial picture rebounds in 2008, Kraft will likely be left behind.

Brokerage analysts are bored by Kraft too. According to Bloomberg, 12 of 20 analysts that follow the stock rate it as a “hold” or equivilant. There are 7 buys and 1 sell.

Overall, I looked at this stock because I thought it might be nice defensive play. I also thought that a weaker dollar and rising food prices would help the company. Maybe so, but the valuation is just too high to make it worth my while.