Declaration after independence

by Josh Sosland
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For Kraft Foods Inc. chairman and chief executive officer Irene Rosenfeld, the first quarter ended March 31 was one to remember.

"The first quarter of 2007 was an eventful one for Kraft as we became independent from Altria and began executing the strategic plan we announced in February," Ms. Rosenfeld said. "We expect to see further progress, particularly in the second half of the year, as we set the stage for Kraft’s return to consistent growth."

The spin-off, which became effective on March 30, marked the end of a 21-year era beginning with the 1985 acquisition of General Foods by Philip Morris Companies (later renamed Altria) and the 1988 acquisition of Kraft three years later. Even after its June 2001 initial public offering, Altria maintained 89% ownership of Kraft. As a fully independent company, Kraft, with a market capitalization of $54 billion, is listed in the Standard & Poor’s 100 and 500 indexes.

"The transition has been seamless and our 90,000 employees are eager and energized to write this next chapter in our history," Ms. Rosenfeld said.

Investors are eager as well, anxious that Kraft’s new chapter should have a happier story line than the previous one. Ms. Rosenfeld has been careful to modulate near-term expectations for financial performance at Kraft, particularly following several years of disappointing results under her predecessors. Still, in a first-quarter conference call April 18, Ms. Rosenfeld appeared acutely aware of the need to build credibility by demonstrating the company is on track toward fulfilling its three-year strategic plan and forthrightly recognizing parts of the business that continue to struggle.

Nothing is more important toward restoring credibility than the company’s bottom line, and while first-quarter profits fell from the year before, they were in line with projections.

"Earnings met our expectations," Ms. Rosenfeld said.

Net income of Kraft Foods in the first quarter ended March 31 was $702 million, equal to 43c per share on the common stock, down 30% from $1,006 million, or 61c per share, during the first quarter of 2006. Net sales were $8,586 million, up 6%. Excluding special items, net income in the first quarter was down 5%.

In her first major presentation to analysts in March, Ms. Rosenfeld said Kraft would be putting more emphasis on looking at its portfolio from a consumer perspective rather than a manufacturing point of view. Poking fun of the insiders’ take on the industry, Ms. Rosenfeld asked, "How many people do you know who say, ‘Boy am I thirsty. I could really go for a cold aseptic punch right now’?"

In the April 18 conference call, Ms. Rosenfeld shed additional light on how Kraft is rebuilding its relationship with the consumer. Efforts to improve the quality of key Kraft products already have begun to bear fruit, Ms. Rosenfeld said.

"Our investments in quality and marketing support behind our Mac and Cheese business drove double-digit revenue growth and over 1 point of share gain year to date," she said.

Results have exceeded expectation for Kraft’s DiGiorno Ultimate Pizza, which has distribution across 17% of the United States and will be distributed nationally beginning in June. The company’s Oscar Mayer Deli Creation sandwiches have had "excellent acceptance by the retail trade," Ms. Rosenfeld said.

Updating investors on other pending new product initiatives, first previewed in February, Ms. Rosenfeld said the company’s Fresh Creations prepared salads are being tested in Boston and Denver.

"We continue to learn and make the necessary adjustments to our launch plans to maximize the potential of this new category in our North American business," she said.

Offering perspective on the magnitude of the effort to bolster product quality and invest marketing dollars behind the changes, Ms. Rosenfeld said a "fairly significant" portion of $300 million to $400 million in spending planned for 2007 to energize sales will be devoted to quality upgrades."

"A big part of it is about marketing and investing behind these new initiatives," she said.

Highlighting a change in her management approach at Kraft from her predecessors, Ms. Rosenfeld has deemphasized new product sales in isolation as a metric for success. While Kraft for many years focused total revenues from new products approaching or even exceeding $1 billion, Ms. Rosenfeld noted that ever increasing sales of new products is not a guarantee of overall financial success.

"We’ve chosen not to use that as a metric, simply because that does not speak to the incrementality of (total sales)," Ms. Rosenfeld said. "So everybody gets very excited about the fact that they’ve got a high percentage of new product revenue, and then all of a sudden you discover that your net top line hasn’t increased. So we’ve been forcing the team to think about the aggregate impact of some of these new products."

Still, when asked about the new product innovation, Ms. Rosenfeld reframed the question in a way suggesting that product innovation remains important at Kraft.

"I think it would be helpful for you to have a better sense of how full the pipeline is," she said. "But I will tell you that I’m feeling awfully good about where we are."

Asked to expand on the pipeline and new product disappointments experienced in recent years, Ms. Rosenfeld was guarded. She said she was "quite pleased" with progress Kraft was making in the "task of reframing our categories" and was upbeat on the quality upgrades and accompanying marketing support.

"The reality, though, is that these new ideas are at various stages of validation with the consumer," she said. "And so it’s far too early for us to declare a victory."

Notwithstanding the vision for renewed growth laid out in recent months by Kraft management, one analyst on the conference call described the overall first-quarter results in 2007 as closely resembling the pattern of recent years with sales going up, margins going down and the company investing in brands.

"At some point, we’ve got to see an inflection point," the analyst said.

Ms. Rosenfeld agreed that the upturn had not yet arrived but said that it was within sight.

"As we’ve laid out in our plan, it’s going to take all of 2007 for us to begin to see the inflection point, because we’re making some very significant investments, necessary investments in some of the fundamentals of the business in order to not only get our base shored up in the short term, but importantly to plant the necessary seeds for some of the trajectory-changing initiatives over the long term."

In finding the path for renewed growth at Kraft, it’s important that analysts not paint the company’s product portfolio with too broad a brush, Ms. Rosenfeld said.

"There’s no question there are some businesses that have a greater ability to contribute and those are the ones in which we’re making great investments," she said. "There are others that play a different role. We have some very high margin, strong cash generating businesses, and our opportunity there is to make sure we can continue to protect their margin generation so that we can use that money to reinvest. We continue to look at the portfolio very rigorously with an eye toward understanding which of our brands best fit into our long-term performance goals."

Reacting to the results and conference call, Rob Moskow, a research analyst for Credit Suisse, New York, was wary. Of the idea that Kraft could be reaching an inflection point, Mr. Moskow saw parallels to Campbell Soup Co., which he said successfully reframed its business over a period of years.

"Kraft’s problems are more complex because they are more numerous," Mr. Moskow said. "About half of the Kraft portfolio is still losing share. The good news is that management recognizes the complexity of the situation and has been setting expectations appropriately."

Negative financial trends to overcome

While Kraft Foods Inc. results were a mixed bag in the first quarter ended March 31 as measured by revenue growth, operating income trends were negative across the board. Each of its North American business units sustained declines in operating income, adjusted for special items — Cheese and Foodservice, down 2.8%; Convenient Meals, down 9.2%; Grocery, down 2.8%; Snacks and Cereals, down 2%; and Beverages, down 5.3%.

Irene Rosenfeld, chairman and chief executive officer, was forthright about parts of the Kraft business not yet meeting expectations.

"We’re gaining market share in only about half of our U.S. businesses," she said. "In particular, cheese, mainstream coffee and salad dressing shares fell in the quarter. That’s unacceptable, and we are working on solutions."

In the North America Cheese and Foodservice segment, sales in the quarter were flat versus the first quarter of 2006. Revenues were bolstered by the introduction of value-added products, including Philadelphia ready-to-eat cheesecake and the introduction of Grate-It-Fresh Parmesan cheese with a built-in grater.

At the other end of the spectrum, the traditional cheese business was more difficult in the first quarter ended March 31, said James P. Dollive, executive vice-president and chief financial officer.

"Share was down due to heavy branded private label promotional activity," Mr. Dollive said in the April 18 conference call. "Operating income margin was down as we reinvested favorable pricing and mix into a strong double-digit increase in marketing behind both the base business and new product. While we did lose share of total cheese, we are encouraged by the initial results of our category reframing efforts and expect to see improvement as the year progresses."

Ms. Rosenfeld said further new product introductions are impending in the dairy business.

"We’ve got a number of new cheese items," she said. "Our LiveActive line, our probiotics cheese is coming out in the next couple of weeks. We have our line of KraftSelects that is a real premium offering, and we have a variety of other new products that we believe are the kinds of items that will allow us to be able to add value and then realize the pricing opportunities."

Within the Kraft Convenient Meals segment, the meat business stood as one Ms. Rosenfeld described as on the right track.

"I feel very good about our Oscar Mayer business," she said.

Offering a hint into what she described as a "pretty robust pipeline" at Oscar Mayer, she described directions the company was taking toward "improving the overall nutritional profile of our Lunchables business."

Less upbeat was Mr. Dollive’s assessment of the North America Snacks and Cereals business. While new snack products and merchandising gains drove growth in both cookies and crackers, he said Oreo experienced a sales decline because of a first-quarter price increase.

"Our main disappointment in this sector was in the decline in ready-to-eat cereal revenues as share losses in kid cereals led to lower volume in the quarter," Mr. Dollive said. "Operating profit margins in snacks was down slightly. Looking ahead, we expect these same factors to impact the operating income margin of snacks for the remainder of the year."

Kraft continues exploring ‘wall-to-wall’ concept

A pilot program exploring a dramatically different approach to sales at Kraft Foods Inc. is yielding "very encouraging" preliminary results, said Irene Rosenfeld, chairman and chief executive officer of Kraft.

Ms. Rosenfeld briefly commented on the "wall-to-wall" program during the Kraft annual meeting of shareholders April 24.

The program is just what the name implies, Ms. Rosenfeld said.

"One sales rep covers the entire store wall to wall and is responsible for bringing our portfolio to life on shelf, on end caps and on display," she said. "I’m pleased to tell you that to date the results of this initiative are very encouraging."

Ms. Rosenfeld first discussed the wall-to-wall pilot when speaking at the 2007 Consumer Analyst Group of New York conference in February. There she noted that sales representatives under the wall-to-wall program will use their time more efficiently, spending less time driving between stores and more time in stores building business.

"Just as important though, our sales reps will get insights that can only come from being in the store, on the floor at the point of purchase where consumers are making their decisions," Ms. Rosenfeld said at CAGNY. She noted that the program has been in test since 2004 and the pilot expanded in late 2006.

This article can also be found in the digital edition of Food Business News, May 1, 2007, starting on Page 40. Click here to search that archive.

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