With a portfolio of American classics that would impress any investor, Kraft Foods (NASDAQ:KRFT) seems like an easy dividend choice. The company pays out an annual dividend yield of just over 4%, but there are plenty of details below the headline number. In separating from Mondelez, Kraft picked up a heaping handful of debt and a limited audience.
While the company isn't in jeopardy of disappearing, the seemingly, here are two things Kraft dividend investors need to keep in mind.
Kraft is saddled with a big chunk of debt
There's debt and then there's Debt, and Kraft has some Debt. In splitting from Mondelez, Kraft ended up with about $10 billion in long-term debt. The company is paying it off in roughly $1 billion installments, though it took last year off and is taking another break next year. Right now, Kraft has nowhere near the cash on hand to start to cover its obligation.
That means Kraft is relying heavily on its annual cash flow to make payments. Over the first six months of the current fiscal year, the company generated free cash flow of $454 million. That's not strictly indicative of where the business will end the year. Kraft finished last year with annual free cash flow of $1.5 billion after hitting just $400 million by this point.
The concern is that even if Kraft covers its payments, that doesn't leave much left for strong increases in the dividend. Last year, Kraft spent $1.2 billion of that $1.5 billion in free cash flow to pay out dividends. This year, the company has increased the dividend slightly and is on track to spend even more on payments.
On top of its dividend payment schedule, Kraft is trying to hold back a wave of recently exercised options. With the spinoff and a spike in the share price, options are being cashed in, potentially diluting the pool by increasing the number of shares outstanding. Kraft has successfully fought the rising tide, though, by spending another $235 million on share repurchases in the first half of the fiscal year.
With all the demands for cash, dividend investors seem to be falling down the priority ladder. That's an important point to keep in mind if you're looking for an increase in your payments anytime soon.
Commodity increases hit Kraft's bottom line
While Kraft has managed to juggle its cash commitments, the company faces the added difficulty of growing its top line in a difficult consumer environment. Kraft's brands cover the entire kitchen, and it is trying to gain more momentum in an environment in which consumers are facing rising costs in every category.
The Consumer Price Index has tracked food costs as they increased over the last year, and dining at home costs about 3% more now than it did 12 months ago. That is squeezing American wallets, and making it difficult for packaged food brands to grow.
Kraft is right in the thick of things, as after the split from Mondelez it ended up with the North American segment. That means it can't rely on falling food costs in other parts of the world to balance out weaker sales in the U.S. For the first six months, Kraft's sales fell 1.3% from the same period of last year.
Kraft management has blamed that fall on the rising cost of commodities, and said it is taking steps to right the ship. Pressure remains on the top line, though, which ends up pressuring the bottom line. That means less money could be coming in to meet all those cash commitments mentioned above. One more worry for investors.
The long-term plan
Kraft's size and brand strength mean that it is unlikely to experience a sharp drop from something as temporary as a spike in commodity prices. The real problem is that the company's short-term cash flow is unbalanced. The business was spun off at a time when commodity prices were more reasonable. That would have helped to smooth out cash flow and make it easier for Kraft to easily pay all of its stakeholders.
As things stand, investors look poised to take a hit, if a hit is coming. There's no choice to be made between paying off debt and paying a dividend, and if Kraft is put in a tight spot investors might have to miss out on a dividend, or at least skip an increase in order to keep the business ticking over. It is important for the company to have cash on hand in case an investment or acquisition pops up. With all the pulls on Kraft's cash, it looks like the dividend waters could be choppy for a while.
Andrew Marder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.