Economic Woes or Not, We Still Have to Eat!

08/14/2008 12:00 am EST


George Putnam

Editor, The Turnaround Letter

George Putnam III, Editor of the Turnaround Letter, sees nothing 'cheesy' about this company's potential.

The roots of some of Kraft's (NYSE: KFT) products reach all the way back to 1767, but it wasn't until 1903 that James L. Kraft started his wholesale cheese business from a horse-drawn wagon in Chicago. Today, Kraft produces many of the best-known food brands in the world. With $37.2 billion in revenues in 2007, Kraft is the largest food manufacturer in the US and second-largest worldwide.

In 1988, Philip Morris (renamed Altria) purchased Kraft, and in 2000 it integrated the purchase of Nabisco into Kraft. Altria sold a small stake to the public in 2001, but maintained majority control until 2007, when the company was completely spun off once again. Under Altria, Kraft stagnated, with declining revenues and little product innovation. As a result, the stock price today is within $1 of where it was when first sold to the public in mid-2001.

New management has begun to shake things up. In June 2006, veteran food executive Irene Rosenfeld became CEO, returning to Kraft from a stint at Pepsico running its Frito-Lay division. Rosenfeld established a three-year turnaround plan based on strengthening the management team, improving and expanding existing brands and international expansion.

Several new executives are now in place, and the organizational structure has been revamped. Quality upgrades have improved the consumer acceptance of Kraft's products. Management has cut costs, with annual savings expected to reach $1.2 billion by the end of 2009. Kraft is continuing to reshape its product line, divesting slower-growth brands and acquiring new products. The late 2007 acquisition of Danone Biscuits is expected to greatly expand the company's presence in the developing countries. International sales grew more than 18% in 2007, and with the Danone purchase, overseas operations could represent more than 40% of total revenues this year. The balance sheet is solid and cash flow is strong ($2.3 billion in free cash flow in 2007). This gives Kraft plenty of currency to make acquisitions, buy back stock, or increase the dividend, any of which could boost the stock price.

There are a couple of interesting large stockholders, who are likely to keep management focused on enhancing shareholder value. Legendary investor Warren Buffett has amassed a nearly 9% stake in Kraft. Also, Nelson Peltz, a well known activist, has obtained two seats on Kraft's board of directors. Recent results have been good-second quarter earnings per share up 9%-in spite of higher raw material costs. We expect continued progress from the company's turnaround plan, and we recommend buying Kraft up to 40.

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