View Full Version : Kraft Foods Inc

19-09-2010, 11:11 AM
Kraft Foods Incorporated is a large conglomerate food manufacturer and marketer, specialising in snacks and confectionary. It has a complex corporate history going back to the early 1900’s and now owns a range of iconic labels around the world. As Chairman and CEO Irene B. Rosenfeld described it in a recent strategy report it is a ‘global snacks powerhouse with an unrivalled portfolio of leading brands”. The undisputed world leader in snacks, with annual revenues of $45 billion dollars it is the second largest food company in the world operating in over 170 countries with 11 brands each exceeding $1 billion and 70 that exceed $100 million. Many of these brands have a history of one hundred years or more behind them and hold number leading positions in their market.
Kraft (KFT) is listed on the New York Stock Exchange and is a component in the Dow Jones Industrial Average since September 2008 – as well as the Standard and Poor’s 100 and of course the SP 500. Ranked for the last two years at number 53 in the Fortune 500, Kraft’s largest shareholder is the revered Warren Buffet (via Berkshire Hathaway) and with the share price currently near to its 52 week high this last year has seen the company’s share price outperform both the Dow and the SP500.
Although only listing on the NYSE in its current form in 2001 the origins of the company can be traced back to James L. Kraft who in 1903 started a cheese business in Chicago and was soon joined by his brothers. By 1912 the company was operating in New York and preparing for international expansion. By 1916 it made its first acquisition and in the 1920’s it listed on the both the Chicago and New York Stock Exchanges and aggressively expanded through takeover and consolidation of rivals and other compatible companies at home and in England and Europe. By 1930 it had 30% of the US cheese market and during World War 2 it was exporting 4 million pounds of cheese per week to the UK. In the post war decades – an era of growing prosperity – the company, expanded its product range and its markets via acquisition, and continued to innovate via product development and savvy marketing strategies.
These methods of growth are a clear distinguishable feature of Kraft history, and we see this continue to this very day as evidenced in the recent hostile $20 billion takeover of Cadbury PLC where executives used internet based video to maximise the effect of their communications strategy just as James Kraft used circulars and advertisements to grow his business in 1911, and how Kraft adopted television programme sponsorship and advertising in the era of television infancy in the 1940’s.
So while it may appear that Kraft is a mature company late in its life cycle with the low growth phase this can imply, Kraft has consistently shown it can grow and develop new business in the face of adversity. Kraft also purchased French biscuit maker Groupe Danone for 7 billion in 2007 where Pepsi-Cola had failed to do so just two years earlier. Kraft would appear to be a skilled operator when it comes to winning over shareholders reluctant to part with their national based companies and so presents itself as a beneficiary of globalization despite patriotic resistance. Kraft also shows it self capable of divesting non performing business so as to maximise its use of capital with the $3.7 billion sale of its American pizza businesses to its main competitor Nestle this year and the $2.6 billion sale of its cereal unit in 2007.

20-09-2010, 08:56 PM
Some ratio analysis for the last three years y/e 31/12

20-09-2010, 09:55 PM

Its clear that there has been fairly sharp reduction in liquidity for 2009. As shown by the current ratio dropping from over 1 (generally considered acceptable) in 2008 to 0.72 in 2009 and this is confirmed by an even worse reduction in the quick ratio from 0.61 in 2008 to 0.37 in 2009.

The reason for this is clearly the large increase in current liabilities in 2009.

Most of the other figures have stayed approximately the same apart from the reduction in cash each year.

If we look at the breakdown of current liabilities on the balance sheet we see Short/Current Long Term debt as moving from 1 billion in 2007 to 1.6 billion in 2008 but leaping to 8 billion in 2009. This is confirmed by examining the Cash Flow statement which shows 10.5 billion cash injection in 2009 as Net Borrowings. This large increase in debt clearly affects the liquidity ratios negatively so the question needs to be asked what the debt was spent on. I’m assuming that this is relating to the 20 billion Cadbury P.L.C. acquisition, which was completed in Feb 2010 as there are also large increases in the Balance sheet for Goodwill and Other Assets. I would attempt to understand these corporate manoeuvrings before interpreting these liquidity ratios too negatively. It is not a good sign to be increasingly indebted, and especially at the short end of the curve however I allow the possibility that this was all under control and is a part of financing a huge hostile takeover. Kraft we must remember is a holding company not a trading company itself. I’ll be looking at the following quarterly results with great interest and would not be surprised to see some longer term financing appear.

21-09-2010, 08:24 AM
The activity ratios, like most of the statistics we are seeing, show an improvement from 2007 to 2008 but decline markedly in 2009 erasing the gains of the previous year and more.


Total Asset Turnover ratio being a measure of Sales over Assets is adversely affected by a growth in the asset base as has occurred here and more so when sales shrink as has also happened over these last three years.
Inventory Turnover being cost of goods sold over inventory shows exactly the same trend as the other statistics with the numerator (cost of goods) decreasing and the denominator (inventory) increasing

These are not encouraging trends and are informing us that not only is activity declining but it is doing so on a growing asset base.

21-09-2010, 11:00 AM


The Interest burden ratio measures leverage but works inversely in that a lower number indicates more leverage , and here we see an increase in the interest burden ratio indicating less leverage – odd given that we know debt has increased significantly. Also, interest coverage, the ratio of earnings to interest payments has increased, showing that the firm has no problems meeting its financing obligations. This is confirmed by the reduction in the pure leverage ratio, assets divided by equity. We know that assets have increased but equity has increased more so.
The overall information regarding leverage is positive in that we are (despite liquidity pressures and increases in debt) not seeing the firm stretching its financial capabilities. We can remain relaxed and be comfortable with this information

21-09-2010, 11:01 AM

Profitability in general is declining. All three measures are lower at the end of the three year period. Returns on assets and sales are higher in 2009 than 2008 (but still lower than 2007) where as return on equity is down this last year after a marginal gain in the previous year. It is somewhat encouraging to see the return on sales – the profit margin - bounce up strongly but shareholders will be somewhat disappointed that their injections of equity are meeting diminishing returns.

Putting all the analysis together I think while there are some negatives these should not be of serious concern at this stage. Krafts largest single market and indeed a lot of the Western world has been going through a severe recession which of course will impact turnover and margins. And we know that Kraft is growing rapidly and is therefore likely to experience a time of reduced profitability while it digests that growth before the synergies are fully developed.

14-10-2010, 01:04 AM
Intrinsic Valuation

Dividend Discount Model

The dividend discount model is a valuation method that sets a value V0 on a security based on all the expected future dividends D1, D2, D3 etc. that will accrue to the share holder bringing these values back to present day prices by using the market capitalisation rate k, which in Capital Asset Pricing Model terms is the required rate of return.
V0 = D1/(1+k) + D2/(1+k)2 + D3/(1+k)3 + ... etc
If we wish to incorporate constant dividend growth into this model then we need to include a value g and we will end up with an equation:
V0 = D1/(k-g)
To apply this model we therefore need to arrive at estimates of dividend growth and our required rate of return
Dividends paid during the 8 completed financial years for Kraft are as shown in the chart
Thus giving an average growth of dividend payment during this four year period of 6.5%
g = 0.065

14-10-2010, 01:07 AM
As explained earlier given the long history of growth in this company with every indication that it is still able and willing to grow this figure seems a reasonable extrapolation without the immediate concern of any plateau or trail off.
To calculate k, given that we calculated the stocks β and the market return in Assignment 1 we can use the Capital Asset Pricing Model equation and input those values
K = RF + [β * (rm­ – RF)]
K = 0.01 + [0.5979 * (0.017 – 0.01)]
K =0.01 + 0.5979 * 0.007
K= 0.01 + 0.0042

The text says that the constant growth DDM model is only valid when k > g. This is because when k = g the denominator will be zero and division by zero is undefined. Its also relevant to say that division by a number approaching zero produces results approaching infinity. When k < g then the denominator will be negative producing a negative result for the share valuation which is also impossible as share prices by the nature of their limited liability can only fall to zero and no further. We also know intuitively that we are looking for a positive result given the company is paying good dividends and they are growing.
With the values calculated above of k = 0.0142 and g = 0.065 we can not meaningfully apply the constant growth Dividend Discount Model as the results fail the requirement that k > g
There are two ways to proceed now.
1. We re-evaluate our inputs
2. We abandon the constant growth model and move to a multi stage growth model on the basis that where an analyst determines g > k then this level of growth is unsustainable in the long run.

14-10-2010, 01:09 AM

There are two inputs into the constant growth DDM, market capitalization or required return, and growth. We have calculated both of these empirically using the information from the previous assignment.
Re-evaluating k

For our required return calculations we used a 5 year period 2005 – 2010 to determine SP500 market returns and our stocks β (the two inputs for calculating required return). The other input the risk free rate we know for certain from the T-Bill rate AND we are assured by Ben Bernanke that rates will remain low for an ‘extended period’ so – if you can trust a central banker - we should have a high degree of confidence in that input

Regarding market returns could it be that our time frame too short? The general consensus on investing in the stock market is that it should be for at least seven years to increase the likelihood of overall growth exceeding market volatility, so its possible our data capture period should have been longer, and yet we know (from stock market index performance since 2000) that even if we had extended the time period to 10 years the results would not be markedly different i.e. low overall returns. Certainly its been a trying decade for equity investors but these are the facts. It seems disingenuous to keep modifying our inputs on the basis that a result is not what we want or expect.
If we were to create a ‘future k’ then I don’t believe it would be significantly different. Market expectations are not high in this ‘unusually uncertain’ economic environment and

14-10-2010, 01:13 AM
Revaluating g

Regarding setting Kraft growth at 6.5% this is quite high a figure to be achieved indefinitely however once again over the time frame since this company listed in 2001 that is the empirical result. It is possible that this rate will tail off – we can see in the dividend chart above that growth was even faster earlier on. It is well known that as a company grows it becomes more and more difficult to maintain growth as the returns must be maintained on an ever increasing capital base. Perhaps we should extrapolate the rate of change of growth?
Looking at the data in this way where I have plotted the % change in dividends we are able to see the declining aspect of growth more clearly. However it doesn’t really solve the problem we have as on the basis that we have re-evaluated k and not found a fair way to change it from 1.4% we are still facing the fact that unless we estimate constant growth to be less than 1.4% we still have an unusable model. It would seem unrealistic on the basis of the historical information to conclude that Krafts growth will be less than 1.4%. We know Kraft continues to make large acquisitions which certainly allow the possibility (if well managed) that growth can be sustained at least for the medium term.
My conclusion is that only by manipulating the premises and/or the various inputs (making them subjective and not based on the historical facts) is it possible to apply the constant growth DDM to Kraft and the SP500 and achieve a satisfactory result.

14-10-2010, 01:18 AM
Multi-stage growth model

And so if we wish to calculate intrinsic value based around dividends we must move to another model the multi-stage growth model. This is effectively conceding that growth will flatten to a much lower rate at some stage so goes against my previous assertions that Kraft will find ways to continue to grow. I’ve utilized the spreadsheet provided by the text book website and input the relevant variables such as the actual dividends and from those calculated the historical dividend growth. For 2010 onwards I have reduced dividend growth by 1% each year until 2016 where growth terminates at a subjective 1% or 0.01. Future growth rates are in the blue shaded cells
This values the stock at $271 compared with the current market value of 31.50 so is either telling us the model (and or its assumptions/inputs) is incorrect or we should be buying the stock with all leverage we can muster.
The model is of course sensitive to some of the inputs especially k. If we substitute the value 0.042 for k – implying we require a return of 4.2% from the share then the PV of the cash flows reduces to be equal to the current market price. This is telling us how the market values the share.

14-10-2010, 01:20 AM
Relative Valuation method

As provided the formula for valuing a company using the relative valuation method is to use the industry sectors price earnings ratio and apply that to the company itself. Yahoo Finance provides us with a 11.2 PE ratio for the Foods – Major Diversified sector that Kraft belongs to. Krafts earnings per share for the year ending 31/12/2009 were $2.04 according to Marketwatch.
11.2 (av sector P/E ratio) * 2.04 Kraft EPS = $22.84.

This is significantly below the current market value of $31.50 though given we are using 2009 end of year numbers we could consider comparing it with the market price then which was $27.33 – still a significant discount.
I think its easy to criticise the relative valuation method as firstly it is using the broad brush of the sector average to value earnings. Clearly with a current forward looking P/E of 13.5 the market values Kraft higher than some of its competitors which is understandable if historical growth rates can be achieved consistently in the future.
I believe that the current economic climate is affecting the ability of models to value stocks that display good growth as (the US) is experiencing historically abnormal low interest rates on government securities that determine the measurement of the risk free rate. Growth is so anaemic overall that models that utilize expected returns based on current and previous low growth rates are outputting distorted values. Or, they could be telling us that where growth can be achieved it should be valued very highly

14-10-2010, 01:21 AM
Future Prospects

It is well known that in recessionary environments consumers reduce expenditure and this makes it harder for companies to grow and for them to retain profit margins. However it has also been reported that consumers still enjoy treating themselves where they can do so inexpensively. The confectionary market is well positioned to avoid the worst effects of this prolonged downturn and this is the position of strength that Kraft now finds itself in – strong cash flows and low share prices mean that now is a good time for the company to purchase growth on a scale that it would find very hard to create organically.
Having now purchased Cadbury PLC the future for Kraft is looking very sweet. Although their offer price had to be raised to gain acceptance and the new price valued the chocolate maker at 13 times 2009 earnings this is not high with comparable P/E’s for other chocolate makers such as Hersheys at 16-20. Also it is likely that there will be large synergies between the merged businesses.
What I think this tells us about Kraft is that it retains confidence in its ability to acquire new business and expand into new markets thus diversifying itself from its American home base and setting itself up to enjoy the growth opportunities being offered in the emerging markets such as Brazil and China where not only are their economies strong but their income per capita is growing too.
Humans love to snack on yummy foods and Kraft is there ready to deliver with an abundance of famous and well established brands - its hard to see how this business will not only succeed but continue to grow.
Recommendation : Kraft should be a core holding of any portfolio and offers a 3.7% yield on current prices. BUY and HOLD

14-10-2010, 01:23 AM
thought I would post the rest of the assignment as it got the highest score of 94

any comments?