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What's Appetizing in the Kraft-Mondelez Split?

Jeremy Glaser
Erin Lash, CFA

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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Glaser: Let's look at the global snacks business then, Mondelez. Obviously, you mentioned this is going to be a much faster-growing business. Where is that growth coming from?

Lash: The growth is coming partly from the fact that Mondelez is going to derive more than 40% of its sales from faster-growing emerging and developing markets, and obviously, those businesses grow in excess of where we are seeing developed markets grow. In addition, snacks tend to grow faster than other areas of the packaged food space, particularly confectioneries. And overall, there is less private-label competition and penetration in the snacks and confectionery arena. So, growth has been propped up there, as well. Mondelez maintains white space to further extend the distribution of its products in those markets.

Glaser: It sounds like people are much more likely to grab that branded Oreo, but maybe will go for that generic cheese if times are a little bit tougher. Where does our moat rating come out for the snacks business?

Lash: For Mondelez, we rate the moat as wide at this point in time given the expanse of global scale that the firm operates with as well as the strong brand portfolio and the minimal private-label competition that exists in that market.

Glaser: We have a new wide-moat firm. What about the valuation?

Lash: The valuation we think right now is more fairly valued. While we can't argue with the growth prospects that we expect to exude from that business, we also think that the firm could struggle in two regards. One, the gum business has not performed where management thought it would, particularly in light of the challenging macroeconomic conditions, as well as some of the company's own missteps, particularly putting too many brands on the shelf or too many products on the shelf.

In addition, tastes and preferences vary around the globe for snack offerings, and so, the firm is not going to just be able to take what's worked over in the U.S. and in Europe and transplant those offerings into emerging markets. It is going to have to do some research and invest behind its brands to ensure that they don't stumble.

Glaser: Well, Erin, it sounds like a good idea for now and maybe another idea to keep on the radar. Thanks for talking with me today.

Lash: Thanks for having me.

Glaser: For Morningstar, I am Jeremy Glaser.