Mondelez establishes global ambitions

by L. Joshua Sosland
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NEW YORK— With the bar for financial success modestly set, Mondelez International Inc. is poised for financial outperformance, according to two investment analysts initiating coverage.

While Mondelez was split as the faster growing part of Kraft, Andrew Lazar, an analyst with Barclays Capital Inc., said financial targets are not especially ambitious.

“Essentially, Mondelez is targeting organic top-line growth of at least 5%, in line with previous guidance for consolidated Kraft — though with its low-to-no growth business being spun off as Kraft Foods Group, this would appear to be a much more realistic and achievable annual outcome,” he said. “Based on an in-depth look at Mondelez’s category/geographic exposure.”

Mr. Lazar, who rates Mondelez an “overweight,” said the objective of 5% to 7% top-line growth over time “appears achievable to us.” He said share gains may be needed to achieve the high side, but a pro forma review of the business suggests the target was achieved over the past four years.

Mondelez comprises the global snack and food brands of what had been Kraft Foods, Inc. The company has $36 billion in annual sales and operates in 80 countries, with a portfolio of billion-dollar brands that include Cadbury and Milka chocolate, Jacobs coffee, LU, Nabisco and Oreo biscuits, Tang powdered beverages and Trident gums.

Robert Moskow, an analyst with Credit Suisse, described Mondelez as largely an agglomeration of the major acquisitions made by Kraft after the 1990s.

“Mondelez is essentially the combination of three big snack company acquisitions that Kraft made beginning with Nabisco in 2000, followed by LU in 2008, then Cadbury in 2010,” he said.
While acquired with the intention of boosting the growth at Kraft, dragged down by more mature categories such as cheese, coffee, mayonnaise and packaged meats, Mr. Moskow said the business combination proved ill conceived.

“(The) grocery and snack businesses don’t mesh well to begin with,” he said. “Snack businesses require direct-to-store delivery sales networks that can penetrate deeply into small mom and pop convenient stores, bodegas, and kiosks. They utilize complicated back office infrastructure to support small, high frequency transaction.

“Grocery businesses tend to be lower cost because they don’t require as much in-store attention and they ship in less frequent truck-loads. Kraft Group’s grocery business also has two refrigerated businesses that sell to completely different procurement managers. As a result, Kraft had a great deal of trouble capitalizing on the scale that this portfolio breadth provided. They needed depth, not breadth.”

Credit Suisse, which rates Mondelez “outperform,” said the company’s focus on the snack category (accounting for 75% of sales), gives it a stronger growth profile than regular processed foods.
“Snacks can be consumed during many different times of the day as opposed to other packaged foods categories that are limited to specific meal times,” Mr. Moskow said.
“(Its) brands are #1 and #2 in almost every category and geography in which they compete,” Mr. Moskow said.
Elaborating on how Mondelez will grow sales by as much as 7% per year, Mr. Lazar said developing markets need to grow at double digit rates, including mid to high teens in the BRIC markets, while developed markets need to grow at low to single digit rates. Currently, developing markets account for about 44% of total sales. A third of those sales come from the BRIC markets.

“Our analysis indicates that Mondelez BRIC markets have indeed delivered mid teen (15%) category growth over the last five years, implying that the company can deliver on that piece of its guidance by simply maintaining its market share and growing in line with the category,” Mr. Lazar said.

Because developed markets continue to account for more than half of annual sales, at least for the time being, the markets “will need to do their fair share as well, otherwise total company growth can be at risk,” Mr. Lazar said. He acknowledged management concern about “challenging conditions in developed markets” in 2013.

The headwinds in Europe helped prompt Deutsche Bank to rate Mondelez a “hold,” said Eric Katzman, an analyst there. He described the 5% to 7% sale growth goal as “too optimistic.”

“Close to 30% of revenue is non-snack and largely tied to the challenging E.U. market,” he said. “Furthermore, global gum (about 10% of sales) has struggled, with no clear turnaround signs.”
Margin improvement at Mondelez also is a possibility, Mr. Lazar said, noting that the company’s profitability in Europe, with a 12.5% margin, significantly lags Nestle, at 15.6%.

Nearer term, Barclays expects earnings in fiscal year 2013 to exceed management forecasts of $1.50 to $1.55 per share by 10c to 15c per share.

With the opportunity for greater growth from developing markets comes heightened risk associated with foreign currency translation, Mr. Lazar said, adding that other leading consumer packaged goods companies face similar conditions.

Mr. Moskow agreed, noting that management concern, expressed in August, was predicated on a weaker Euro. Instead, the Euro has strengthened since that time to the extent of adding 4c to 5c per share to Credit Suisse’s earnings forecast for Mondelez in 2013.

“In addition, earnings are temporarily depressed by inefficiencies related to the spin and dis-synergies, which will melt away,” he said. “In total, we believe the company’s true earnings power is closer to $1.62, which management could either choose to realize right away, or reinvest to secure a big step in 2014 to $1.80.

By contrast, Mr. Katzman said Mondelez margins are low for a reason and likely will not recover soon.
“While the 13% EBIT margins appear low, we note a competitive global biscuit category and historically Europe’s excess capacity in chocolate explain the profit level,” he said. “Furthermore long term goodwill amortization will limit EBIT margins. With the split, it is possible Mondelez’s focus will improve fundamental performance versus a poor historical track record in snacks. We note Cadbury driven cost savings (soon to end) have been a key to recent EBIT expansion.”
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