The J. M. Smucker Company (NYSE: SJM) is trading to the upside in the early session today, following a third quarter earnings report that saw the consumer staple maker top views led by a strong surge in coffee sales.
It is common to find investors and writers talk about food companies like Kraft (NYSE:KFT) in the context of "people always have to eat." While that is true, it overlooks a fairly important point - nobody has to eat their food. There is a big difference between food companies like Kraft and Kellogg (NYSE:K) and the likes of ConAgra (NYSE:CAG) and investors should not just lump all food companies into the same basket. While Kraft certainly has a tough environment to navigate and may have indeed overpaid for Cadbury, this is a food company that merits more than casual attention.
The Quarter that Was
All in all, Kraft delivered a quarter that was a little complicated (due to charges and adjustments and the like), but pretty much consistent with expectations. Sales, though, were a bit higher than the analysts expected. On a reported basis, Kraft served up 5.7% organic revenue growth this quarter, or 4.7% if the effect of an extra week in the quarter is subtracted. The legacy business delivered growth of 5.3%, while Cadbury chipped in about 2.2% organic growth.
Looking at profitability, Kraft's story was like so many others this quarter - mixed. The company's gross margin fell by two points and that appears to be worse than most analysts expected, as the analyst community was apparently surprised by the extent of cost inflation in the market. On a more positive note, the company trimmed down operating expenses better than most expected (and the Cadbury integration is ahead of schedule) and recaptured some of that lost margin, as adjusted operating margin ticked up 20 basis points from the year-ago period. Continuing an oddly consistent trend (at least among the large corporations), Kraft reported lower-than-expected taxes and that helped the company meet the earnings-per-share target for the fourth quarter.
The Road AheadWhile U.S. government officials may not be seeing inflation, Kraft is (remember, things like energy and food input prices apparently are not "real" inflation, so they don't count). To that end, the company lowered guidance for 2011 and talked about input price increases in the high single digits. Although all food companies are in this same boat to some extent, Kraft may have a few extra levers to pull in terms of trimming operating costs and that may help mitigate some of the squeeze. That said, the company is also facing the loss of Starbucks (Nasdaq: SBUX) and that will take some steam out of the results as well.
Kraft also has at least one other factor working in its favor - a broad global presence. In terms of sales, Kraft is near the top of the list of North American food companies that get a sizable percentage of sales from foreign markets. Better still, those markets are growing substantially faster than North America or Western Europe. Is it coincidence that companies like Unilever (NYSE:UL), Coca-Cola (NYSE:KO), Pepsico (NYSE:PEP) and Nestle (Nasdaq:NSRGY) all have solid emerging market exposure and better-than-average returns on capital and growth? Probably not ... and it is a solid argument that Kraft is hanging with the right crowd in that respect.
The Bottom Line
Did Kraft overpay for Cadbury and destroy shareholder value? Maybe so, but it is not readily apparent in the results right now. It may also prove to be the case that Cadbury was a synergistic merger that also expanded Kraft's opportunities in some significant non-U.S. markets. Time will tell.
In the meanwhile, Kraft is going to have to navigate a tricky maze of coping with higher input prices through both restrained price increases and improved internal operating efficiencies. If the company pulls this off, this looks to be one of the better food companies to own. Kraft may not get the benefit of the boom in agriculture (since high prices can actually hurt them more than help) and cost worries might keep a lid on the stock in the short run, but value-oriented investors may find more to like in Kraft shares than they expect.
Disclosure I am Long KFT, UL, PEP, and K shares.
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