Kraft Foods Inc. (KFT) has started the year 2012 with strong operating earnings (excluding integration, spin-off and restructuring charges) of 57 cents per share. The first quarter 2012 results exceeded the Zacks Consensus Estimate by a penny and the prior-year quarter earnings (excluding integration costs) by 5 cents, driven by solid top-line growth and effective cost management.
Including the one-time charges, reported earnings were 46 cents per share in the first quarter 2012, up 2.2%.
Revenues and Margins
Revenues in the quarter rose 4.1% to $13.1 billion, in-line with the Zacks Consensus Revenue Estimate. Organic growth was 6.5%, which excludes impact from divestitures and currency and includes the termination of Starbucks CPG business with Starbucks Corporation (SBUX). Organic growth was driven by new product launches and impressive growth of Power Brands in all geographic regions, North America, Europe and developing markets.
Pricing contributed 5.5 percentage points while volume/mix added 1.0 percentage point to growth. Kraft’s 21 Power Brands grew 11% to boost top-line growth in the first quarter.
Adjusted operating income surged up 5.8% to $1.9 billion in the quarter, driven by effective input cost management and volume/mix gains. Adjusted operating margin expanded 0.2 percentage points to 14.1% in the reported quarter.
Regional Details
North America: Revenue surged 1.3%, while organic revenue increased 3.0% in the first quarter. Higher pricing across each business segment fueled the growth. The 15 Power brands in North America contributed significantly with growth of 6% in the quarter.
Segment operating income increased mid-single digits, on the back of continued focus on cost management and lower SG&A expenses which offset an unfavorable impact from volume/mix.
Europe: Revenues were strong despite volatile market conditions, with a rise of 4.5% in the first quarter, while organic revenue bolstered 7.2% in the quarter. Positive volume/mix contributed 4.4 percentage points to the increase benefiting primarily from the early Easter this year. The 15 Power Brands in Europe also fueled growth by 11% in the first quarter of 2012.
Segment operating income increased mid-teens in the reported quarter. The results improved on the back of cost control, lower overhead costs and positive volume/mix.
Developing Markets: Revenues climbed 8.5%, while organic revenue increased 11.5% in the quarter. Higher pricing and positive volume/mix contributed to the increase. The 10 Power Brands in the developing markets also fueled growth by approximately 18%. Among the strong performers was Tang, which increased more than 20%; Lacta was up 30% and OREO was up nearly 40% in the quarter.
Segment operating income increased double-digit in the reported quarter, driven by positive volume/mix, effective management of input costs and a gain on the sale of an asset in Russia.
Spin Off Update
Kraft is in the process of separating into two independent public companies: a high-growth global snacks business and a high-margin North American grocery business. Global snacks will consist of the current Kraft Foods Europe and Developing Markets units as well as the North American snacks and confectionery businesses.
The North American grocery business would consist of the current U.S. Beverages, Cheese, Convenient Meals and Grocery segments and the non-snack categories in Canada and Food Service. The spin-off is expected to be completed before the end of this year.
Following the spin-off, the North American grocery business, which includes popular brands like Oscar Mayer meat and Kraft cheese, will be an independent, public company and will be called Kraft Foods Group. The Global Snacks unit will be named Mondelez International, Inc.
2012 Outlook
Kraft reaffirmed its previously provided organic revenue guidance to grow approximately 5% in 2012, including a negative impact of up to one percentage point from product pruning in North America. The company continues to expect 2012 operating earnings to grow at least 9% on a constant currency basis, which is within a long-term target range of 9% to 11%.
Our Recommendation
We currently have a Neutral recommendation on Kraft Foods. The stock carries a Zacks #3 Rank (a short-term Hold rating).
Overall, we are encouraged by Kraft’s strategy of continued cost management, price increases, expansion into emerging markets and continued strong momentum from its designated Power Brands. Further, the split of its North American business is expected to allow Kraft to focus on its distinct strategic priorities and allocate resources optimally. However, we remain concerned about rising input costs and vulnerability to currency translations.
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