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By Jeremy Glaser and Erin Lash, CFA | 10-01-2012 01:30 PM

What's Appetizing in the Kraft-Mondelez Split?

Dividend investors might find Kraft's cash flow appealing, while Mondelez appears to be more fairly valued.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. As Kraft splits its business, which side is more attractive for investors today? I am here with Erin Lash. She is a senior equity analyst at Morningstar, and we are going to dive into this issue.

Erin, thanks for joining me.

Erin Lash: Thanks for having me.

Glaser: So, let's talk a little bit about the impetus of the split. A lot of consumer packaged goods companies seem to be getting smaller nowadays rather than larger. What's happening here? why did Kraft think this was a good idea?

Lash: Kraft's motivation differed from some other companies like Sara Lee and Fortune Brands, which primarily split their business because there weren't synergies between the segments. However, Kraft's motivation stems more, from our perspective, in terms of garnering a higher multiple for its global snacks business, which is obviously faster-growing and we think was being underappreciated by the market when combined with the more mature domestic grocery operations.

Glaser: Let's take a look at those grocery operations first. [With that being a] stand-alone company, what's your assessment, what are the strengths and weaknesses of this new business?

Lash: The grocery business, all the sales are going to result from North America, so it's obviously a more mature market. It's not going to have the growth prospects that will result from the global snacks operations, and there will be significant private-label penetration or competition in the grocery business.

However, that said, we think the business is going to generate a significant amount of cash, and we think that's being underappreciated by the market at this time. And we think that the shares of the new Kraft Foods will be particularly appealing for income investors given that paying dividends is [the firm's] stated priority of cash.

Glaser: So, you are not too worried about a lot of cash flow being used for more empire building. It's really going to get returned back to shareholders?

Lash: No, we think actually, obviously, returning cash to shareholders is a top priority, but we also think that the firm will continue to invest behind its brands, both in the form of product innovation and marketing support. Previously, the grocery operations in our opinion had been utilized as a more of a cash cow to fund growth within the global snacks business, and we think that these brands have been underinvested in. So we think that the firm will utilize a portion of its cash to kind of propel growth and prop up growth in those more mature brands.

Glaser: So, looking at the yields, where does our fair value estimate come out, and what would the yields be if the shares hit that fair value?

Lash: The annual dividend yield on our fair value is right around 4% and even higher when you look at where the shares are trading right now.

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