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Tuesday, March 9, 1999

An Investment Opinion
by Warren Gump

It Isn't Oreos 'N Milk

Today's news from RJR Nabisco (NYSE: RN) is certainly positive for stockholders, but investors should be sure to understand what they're buying before biting into today's hoopla. The stock added $1/8 to $28 3/4 after the company announced the sale of its international tobacco operations for $8 billion and the spin-off of its domestic tobacco business, leaving an 80.6% stake in Nabisco Holdings (NYSE: NA) as RJR's primary asset. While this deal may unlock some value for RJR Nabisco shareholders, investors should recognize that most of RJR Nabisco's value lies in its Nabisco stake. Recent performance from Nabisco raises questions as to whether it is really that great of a buy.

It's somewhat surprising that Nabisco is struggling since it has such a dominant role in the food industry. The company obtains 50% of its operating profit from the biscuit division, which makes eight of the ten most popular cookie and cracker brands. Some of the familiar names sold by the company include Oreo, Chips Ahoy!, Newtons, Ritz, Premium, and Triscuit. While the company has a leadership position in this field, that dominance has been slipping. In 1997, overall market share fell to 39.6% of the cookie market and 53.7% of the cracker market, down a significant 1.4 and 2.1 percentage points, respectively. Market share continued to drop in the first three quarters of 1998, although it did turn around a bit in the fourth quarter.

Through its U.S. Food Group, Nabisco sells a panoply of other products like Lifesavers candy, Planters nuts and snacks, A1 steak sauces, Grey Poupon mustards, Milk-Bone pet snacks, and Cream of Wheat. Accounting for 31% of operating profit, the division boasts that most of its products are either first or second in their respective categories. The company's international operations account for the remaining 19% of operating profit. In addition to many of the products sold domestically, this division sells canned fruits and vegetables, pasta, and other items.

My initial impression would be that a company with such a powerful stable of products would be a terrific investment. Looking beyond the glamour of its brands, however, operating results posted by Nabisco over the past year have been anything but exciting. Earnings per share fell 25% last year, excluding restructuring charges and other items, on a 4% sales decline.

Sales for the biscuit division were flat and operating profit fell 22%, hampered by increased marketing expenses (that didn't yield substantial near-term revenue gains) and investments in its sales force. Over in the U.S. Food Group results were a little better. Sales grew 3% and operating profit increased 7% as strength at Planters, A1, pet products, and hot cereal offset a downturn at Lifesavers. In the international division, sales fell 2% and operating profit dropped 13%. Results were hurt by adverse currency changes and falling volume, particularly in Brazil.

Okay, results from last year are history. As investors, we need to look ahead. What is going to happen in 1999 and future years? Some investors might be enthused about a restructuring plan the company started implementing last June. The company took $586 million in charges last year to streamline its manufacturing and distribution operations, reconfigure its sales force, and reorganize certain operations. Management hopes to save about $100 million annually from these maneuvers.

Let's hope this restructuring will be more effective than the last one. In 1996, the company took $525 million in "one-time" restructuring charges to save $200 million in annual costs. If those savings were realized, the company's underlying performance is much worse than it appears. Remember, between 1996 and 1998 operating profit fell from $1.2 billion to $1.1 billion. My suspicion is that the restructuring didn't have the desired impact. Hence, two years later, another major "one-time" half-a-billion dollar charge.

Off of last year's weak results, analysts polled by First Call are projecting that 1999 earnings per share will grow a whopping... drum roll please... 7%. Looking out to 2000, Nabisco is expected to grow earnings another 17%. Assuming these projections are accurate, the company's earnings per share will actually decline 6% between 1997 and 2000. While some people might say I don't see the bigger picture, it doesn't make a heck of a lot of sense in my mind to pay 35x 1999 earnings projections for a company in such a predicament.

Nabisco certainly has a stable of top-notch brands. Unfortunately, the current management team has not shown an ability to reap their value. Perhaps the folks at RJR Nabisco will be able to help re-energize operations when their time is freed from tobacco legislation. Until I see more tangible results of a turnaround, however, my money isn't going anywhere near Nabisco. Right now, I think a handful of Oreos dipped in milk is a heck of a lot more appealing than Nabisco stock.

For further details on the RJR Nabisco split and sale of international tobacco operations, see today's Fool Plate Special. For discussion, head to the Fool on the Hill message board or the RJR Nabisco board.

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