A year after announcing the split of Kraft Foods (KRFT +0.00%) into two separate entities, investors finally got a peek at its first earnings results. The now-separate international unit, Mondelez International (MDLZ +0.28%), reports earnings after the close of business Nov. 7. Leading up to the split of Kraft with its focus on the North American grocery business, and Mondelez and its emphasis on the international snacks business, investors heard all the usual pre-divestiture rhetoric.
In Kraft's case, the "brave new world" oratory turned out to be spot-on. CEO Tony Vernon put it like this in Kraft's Q3 earnings release: "Our third quarter results demonstrate the power of our brands, our people and our innovation," as well as his goal of becoming, "the best food and beverage company in North America." The likes of General Mills (GIS +0.41%), Hormel (HRL +1.37%), and Tyson (TSN +0.79%) will certainly have something to say about who's top dog in the North American food industry. But after Kraft's Q3, there's no doubt Vernon and team got off to a solid start.
The results
Net revenues increased to $4.61 billion in the most recent quarter, an improvement of 3% versus Q3 of 2011, and above analyst expectations of $4.56 billion. Earnings also exceeded analyst estimates of $0.69 a share, jumping 13% to $0.79 a share ($470 million total) in Q3, compared with $0.70 ($417 million total) last year. That's impressive stuff, but it doesn't even do Kraft's results justice. The most recent quarter includes a $54 million restructuring charge as part of the previously announced (Oct. 29) $650 million in total charges relating to costs associated with the divestiture of Mondelez.
Adding more fuel to the Kraft fire was the 7.6% improvement in operating income compared with Q3 of 2011, in large part driven by gains in productivity. For shareholders of any manufacturer, food or otherwise, improvements in productivity along with increased revenues is the ideal double-whammy. And it gets even better. That $54 million restructuring charge also negatively affected operating income. And that 7.6% operating income improvement? If not for the charge, operating income would have jumped another 7.7% compared with last year.
The icing on Kraft's Q3 cake is that Vernon went on, reinforcing Q4 and fiscal 2012 guidance, and even more importantly confirmed its expectations for 2013. In other words, Q3 wasn't a "one-hit wonder," as Vernon fully expects that Kraft's results will continue to improve, irrespective of the impact on commodity prices after the Midwest heat wave this past summer. To its credit, Kraft was able to decrease the cost of sales by 3% while at the same time show a 0.6% increase in what it refers to as "favorable pricing." After the tough Midwest growing season, successfully passing along price increases to consumers without cannibalizing sales is a necessity, and Kraft is doing just that.
But what about investing in Kraft?
After an initial pop in Kraft's stock price at the open, it settled into trading at about the same share price it started the day at -- $44.50. At current levels, Kraft is on the low end of the industry relative to value, trading at just under 14 times trailing earnings, and its 1.4 price-to-sales ratio also compares favorably. To give you an idea, Kraft's closest competitor, General Mills, is trading at 15.4 times earnings with a 1.5 price to sales ratio.
As for Hormel and Tyson, the two meat processing and packaging leaders play in a slightly different sandbox from Kraft. With that said, Hormel is fairly priced at its current 16.5 times earnings, to go along with its 2% dividend yield. Tyson, on the other hand, continues to struggle with squeezed margins and overcoming the lowering of revenue guidance. Recent talk of a nearly $1 million settlement with workers at a Tyson meat-packing plant hasn't helped.
As for Kraft, its improvement in gross margins in Q3, from 30.5% to 34.5%, stacks up with others in the industry, and don't be surprised to see margins continue to improve as cost-cutting measures and growth along multiple product lines are maintained heading into 2013.
The caveat to Kraft right now is next year's guidance of $2.60 a share. The earnings expectation for 2013 increases Kraft's forward P/E to 17, calling into question its relative value. But keep in mind the restructuring costs Kraft will take over the next several quarters, as those will affect net earnings. Going forward, a focus on Kraft's non-GAAP results will determine whether it does become "one of the best food and beverage companies in America." There's no denying that Kraft certainly hit the ground running.
