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Will Kraft Dividend Investors Go Hungry?

Josh Peters, CFA

Josh Peters: Last week's offer by Kraft Foods to acquire Cadbury of England for $16.7 billion is still making news around the globe. However, there was one other piece of news from Kraft last week that, for an investor like me, is equally as important: For the first time since the company came public in 2001, it decided not to raise its dividend in the third quarter.

Hi, this is Josh Peters, editor of Morningstar DividendInvestor.

Kraft is the kind of stock that a lot of dividend investors--people looking for retirement income or to reinvest dividends for future retirement income--look to in order to provide them with a good yield. Right now, Kraft's stock yields over four percent.

Now, Cadbury, with candy and chocolate businesses around the globe, could make a very good acquisition for some larger food company. And as the world's second-largest food company, Kraft certainly qualifies. Kraft also doesn't have much exposure right now in the confectionery industry anywhere in the world, so this could be a good strategic add-on to their portfolio of brands.

However, there's a little bit more to the story, and it has me a little bit concerned, specifically about Kraft's dividend and the effect this acquisition could have on Kraft's shareholders.

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For the first point, this acquisition will require Kraft to do a very good job--a better job, in fact, than Cadbury's own management has done--of managing and bringing down Cadbury's costs. Part of the $16.7 billion offer is really predicated on Kraft's ability to bring down these costs.

And at the same time, Kraft has not done all that good of a job, at least not yet, in improving its own cost structure, bringing down its own operating costs, and improving its own margins. So adding additional businesses that need restructuring and cost savings into the fold--this may not be the best time to do that.

Another factor to consider is that Kraft will be looking to take on additional debt in order to fund this transaction. Right now, Kraft is offering a mix of cash and stock in order to buy Cadbury's shareholders out. Cadbury may ask for more money, or they may just ask for a larger cash proportion. Either way, Kraft will be looking to borrow more money. This, in turn, will mean another mouth to feed at Kraft's table, more bondholders who are competing with shareholders for Kraft's free cash flow.

I wouldn't be at all surprised, especially with the signal sent by Kraft's decision not to raise its dividend when it had for so many years in a row, that a dividend cut could be required, anywhere from a third to a half of Kraft's current dividend rate, in order to pay down the debt associated with an acquisition of Cadbury.

Now, it's very possible that, if Kraft is successful in acquiring Cadbury, and doesn't pay too much, that this could prove to be a good strategic move for the company in the long term. But for shareholders who, like me, are interested in being paid in the here and now through large cash dividends, this acquisition may not be the best development.

So this is something that Kraft's shareholders, many of whom have bought the stock for its four-percent-plus yield, will want to monitor closely, and perhaps even consider alternative uses of their capital.

If you're interested in more perspectives like these, on companies and dividends and how they play into an investor's portfolio, then be sure to check out Morningstar DividendInvestor. You can find more information at mdi.morningstar.com.

Again, this has been Josh Peters, editor of Morningstar DividendInvestor.

Thanks for watching.