Dairy Costs Dump on Kraft

Ever find yourself walking through the aisles of the grocery store, getting sucked into purchasing something with creative, brightly colored packaging, only to realize that the item inside is just ordinary? Kraft Foods (NYSE: KFT  ) doesn't just use this technique in the marketing of their products. It also employed that strategy for its third-quarter earnings release.

The company's press release boasted, "Kraft Foods Reports Continued Top-Line Momentum." Good thing we Fools aren't impulse buyers, because if you dig a little deeper, you'll see that the appealing package doesn't accurately describe what you find inside.

Sales growth has the Real seal
True, the company did report a 9.8% increase in sales for the quarter, showing some positive sales momentum when compared to a 7.4% increase year to date. Organic growth was solid at 6.2%, with 2.5% coming from currency effects and 1.1% from acquisitions. Revenue growth like this normally translates into solid profits.

Good cheese gone bad
But in Kraft's case, the top-line "momentum" didn't trickle down to the bottom line. Earnings per share on a reported basis were $0.38, a decline of 15.6% from the prior year. Excluding unusual items, the picture looks somewhat better -- $0.44, or a decline of 4.3%. The one scrap of good news in these lower earnings: The company did beat consensus analyst estimates by $0.02 per share, which propelled the stock higher shortly after the release.

The earnings culprit is "higher input costs," meaning that dairy raw material costs rose more quickly than the company could hike its prices to compensate. For example, raw material costs to make cheese, a key product for Kraft, have skyrocketed 40%.

More of the same to come?
The company expects third-quarter trends to continue for the foreseeable future -- sales momentum accompanied by earnings declines. Kraft affirmed current full-year estimates in the range of $1.80 to $1.82, excluding items that affect comparability.

Earlier this year, I had a more positive view on Kraft, but the stock is starting to look less attractive compared to other consumer-brand giants like Procter & Gamble (NYSE: PG  ) , Unilever (NYSE: UL  ) , Colgate Palmolive (NYSE: CL  ) , Coke (NYSE: KO  ) , and Pepsi (NYSE: PEP  ) . Recently, I compared all of them on key financial metrics, with Kraft at the bottom of the list.

The stock is not cheap on a P/E basis, at 19 times trailing-12-month earnings, and the rising cost of dairy has been affecting the margins and profitability of food processors and restaurant establishments across the board. I don't see much near-term hope, unfortunately. Commodity costs typically move in long-term cycles, driven by supply considerations. Even with good sales momentum, lagging earnings are likely to translate into a dry spell for Kraft investors -- for a while, at least.

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