If you really want to get a feel for one of the companies you're investing in, take the time to work through its conference call. You'll be amazed at the candor with which management talks about the business. Frankly, you'll learn loads of stuff that you won't find in a press release.
Kraft Foods' (NASDAQ: KRFT ) recent second-quarter call was chock-full of valuable intel. Here are some of the more important points you should be aware of.
1. Input increases were partially passed on to customers
During the first half of this year, our sales and share performance were both adversely affected by the temporary dislocation we typically see when we're climbing the commodity costs curve. We have moved aggressively in the space of what are truly unprecedented price levels in certain parts of our commodity basket. For instance, dairy prices continue to redefine price dealings as we progress through the first half of the year, with the average prices of barrel cheese, block cheese, and milk during the second quarter each at record levels.
We responded with price increases of between 5% and 12% across most of our cheese portfolio. ... And meat, beef, turkey, and pork prices for our cold cuts have continued to increase and are at record highs as we speak.
-- CFO Teri List-Stoll
When commodity costs increase, a food company can do one of two things. It can either bite the bullet and eat the costs, which will help maintain volumes and market share at the expense of profits, or it can pass those costs on to customers, which will protect margins and profitability but hurt consumer satisfaction.
2. Price increases haven't been popular with consumers
On a year-to-date basis, we have implemented or announced price increases on products representing approximately half of our portfolio, and for almost 20% of our portfolio we have increased prices at a double-digit rate. As a result, we've seen some dislocation in market share and growth versus the broader industry year-to-date.
Let me give you some numbers that characterize the impact. Let's start with market share. Through the first half, we continue to gain or hold share in roughly 60% of our business on a trailing-52-week and year-to-date basis. But that number slipped to almost 50% in quarter two and the recent slippage is primarily attributable to the categories where we've taken pricing.
Not surprisingly, Kraft lost a decent bit of market share when it hit its customers with price increases. Generally, when prices of brands go up, customers tend to trade down to cheaper alternatives such as private-label products. The good news is that when prices return to normal, or when the alternative products increase their pricing, customers usually trade back up.
3. Consumers' habits are changing quickly
Consumers [are] focused on value, nutrition, and well-being; our customers are coming to terms with change in shopper patterns and channel shifting. The rise of digital media [is] breaking established marketing principles and best practices. And it's not just the confluence of changes, but the pace of the change.
Even in the two years since we became an independent company the pace of change has been dramatic. Yes, the pressure is great to drive traffic for our retailers and to respond to competitors' price-based land grabs in like kind. The second quarter in particular was an intense, crowded holiday quarter, given a late Easter, putting additional pressure on consumer wallets and customer traffic.
-- CEO Tony Vernon
Around 25% of Kraft's business comes from the Wal-Mart channel, and about 40% is derived from its five biggest customers. So Kraft has to pay particular attention to the "land grabs" by its competitors on limited retail shelf space. One way to combat the competition is to be aware of a shift in consumer tastes. As long as Kraft can stay even with the curve, continue to innovate, and meet consumer needs, retailers will continue to give it plenty of space in their stores.
4. Kraft is targeting millennials better
Take A1 original sauce for example. We've repositioned this brand and launched a well integrated social media and traditional marketing campaign to move A1 beyond steak and broaden its appeal to new consumers, like millennials who are cooking up different types of protein for dinner. Consumption is up 3% since the campaign launched versus a 3% decline pre-campaign.
Share is up half a point year-to-date and A1 is starting to grow household penetration for the first time in years. We can do this on big brands as well, Philadelphia cream cheese for example. We talked about the renovation and supply chain improvements on Philly over the past several months and it's paying off. -- Vernon
If you listened to the recent General Mills conference call, it outlined the four growing consumer groups, which are millennials, consumers over the age of 55, U.S. multicultural families, and a growing middle class in emerging markets. You have to like how Kraft is rebuilding interest in older brands, with A1 steak sauce and Philadelphia cream cheese being two perfect examples. Millennials are where it's at, and Kraft seems to be plugged in.
5. Brand renovations are critical
Brand renovations are a must if we are to keep our brands relevant. It is and will be one of our biggest areas for investment. We will continue to innovate to extend our brands into new consumption occasions like we have with our Keurig-compatible cups. We've created a $200 million-plus business from a standing start, just 18 months ago. -- Vernon
Food companies are constantly trying to tweak their product offerings. And that's because consumers change. As those tastes evolve, the company must adapt and refresh some of the more tired products in its portfolio. Taking a zero-dollar business and turning it into $200 million in 18 months is impressive. That is a good indication that Kraft knows how to build out a product category and bodes well for future projects.
Foolish final words
There was a lot of positive mojo in the Kraft conference call. Kellogg recently spoke of failed innovations, but with the reinvention of A1 and Philadelphia cream cheese, and the introduction of K-cups, that seems to be less of a problem for Kraft. Increasing prices is a calculated risk for any company, thus how far it has come at the expense of market share, but you have to feel comfortable that Kraft will right the ship.
Ultimately, the key is being able to adapt to an evolving customer base. Management cited the speed and severity of these changes, and frankly, it's tough for most companies to keep up. But I don't get that sense with Kraft. Growing consumer groups like millennials want different things and Kraft is doing a nice job of identifying and meeting those needs. This leads to greater brand loyalty and should serve Kraft well down the line.
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