Kraft taps into hunger for value

by Josh Sosland
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NORTHFIELD, ILL. — A strong performance from brands targeting budget-minded consumers helped sustain the financial performance of Kraft Foods Inc. in the third quarter ended Sept. 30. Excluding special items, earnings in the quarter were nearly unchanged from last year.

Kraft net income in the third quarter was $1,398 million, equal to 95c per share on the common stock, up 100% from $596 million, or 38c per share. Sales were $10,462 million, up 19%.

"Earnings per share excluding items were equal to prior year as strong gains from continuing operations were offset by higher interest expense and lower earnings from discontinued operations," the company said. "In addition, the company’s commodity hedging activities negatively impacted the current quarter by approximately $180 million, offsetting benefits recognized earlier in the quarter."

Irene Rosenfeld, chairman and chief executive officer of Kraft, took a positive view of the quarterly results.

"Kraft had a strong quarter in a difficult environment," Ms. Rosenfeld said. "Our operating momentum continued with solid top-and bottom-line contributions from all geographies. I am especially pleased that our volumes in the third quarter held up better than expected, despite significant cost-driven price increases and an unsettled economic environment.

"As family budgets are squeezed, our ongoing programs to add value to products through investments in quality, marketing and innovation are paying off."

While the U.S. Grocery Division benefited from gains in products geared toward consumers seeking value, the company overall remains focused on categories with the highest margins and highest growth, said Tim McLevish, executive vice-president and chief financial officer.

In an Oct. 29 conference call in which he reviewed operating results by business segment, Mr. McLevish identified value-added products achieving double-digit sales growth across a range of categories. In coffee, Maxwell House and Tassimo grew by double digits (40% for Tassimo). Products with sales growth topping 10% in other categories included Deli Fresh Cold Cuts under the Oscar Mayer brand in U.S. Convenient Meals, the top five brands of biscuits in U.S. Snacks and the Triscuit brand, also in U.S. Snacks. Additionally, the company gained more than a point of market share in frozen pizza during the quarter.

In U.S. Cheese, volume declined, reflecting a "conscious decision to not chase unprofitable volume during the quarter, particularly in the natural cheese business," Mr. McLevish said. On the other hand, he cited as successes the company’s efforts with Velveeta and Kraft singles as well as its introduction of Bagel-fuls.

Operating income of the U.S. Grocery business was up 5% as sales gains, principally organic revenue growth, more than offset higher input costs.

"Significant volume and mix gains were achieved from marketing the value proposition of Kraft macaroni and cheese and Jell-O dry package desserts," Kraft said. "Lower volumes of pourable and spoonable salad dressings related to cost-driven price increases partially offset the gains."

By contrast, operating income of U.S. Convenient Meals declined 6%. The company blamed a lag in pricing action behind rising input costs, unfavorable mix and overhead expenses.

At the same time, the company cited "favorable product mix" as contributing to a 9% net revenue increase for the division.

Operating income excluding special items was up 69% in the U.S. Cheese division, benefiting from an easy comparison to a weak third quarter last year. Pricing during the quarter more than offset the impact of higher input costs, lower volume and unfavorable product mix. Revenues were up 7%, boosted by price hikes that more than offset the volume slump and the product mix effect.

In U.S. Snacks, operating income rose 4% excluding items boosted by price increases, the timing of marketing expenses and lower overhead costs. Operating profits would have been stronger still but for $25 million of gains from hedging activities recognized in earlier quarters. Net revenues were up 4% with pricing more than offsetting lower volume and unfavorable product mix.

"In biscuits, investment in quality and marketing behind core brands such as Oreo, Chips Ahoy!, and Ritz, as well as the success of new Kraft Macaroni and Cheese crackers, contributed to strong revenue gains in the quarter," the company said. "These gains were partially offset by revenue declines in snack bars, due in part to product pruning, and to a lesser extent, pricing related volume weakness in snack nuts."

Operating income in the U.S. Beverages business fell 2%. Prices and volume growth were not enough to offset the effects of higher input costs and, to a smaller degree, unfavorable product mix. Net revenues grew 7%, benefiting from higher prices and volume growth across coffee, ready-to-drink beverages and powdered beverages. Growth in coffee was attributed to share gains from the Maxwell House restage. Premium coffee sales were weak.

Operating income was up 21% in Canada & North America Foodservice, bolstered by higher prices, higher volume and lower overhead. Net revenues were up 5%. The company said the strength emanated principally from the Canada business rather than food service, which was adversely affected by the "pruning of lower-margin businesses and unfavorable business mix due to a slowdown in casual dining traffic."

In its European Union division, operating income excluding special items jumped 77%, of which 59 percentage points were due to the LU biscuit acquisition. Results also were bolstered by improved product mix, higher prices and reduced marketing spending. Organic net sales rose 2%, reflecting cost-driven pricing actions that more than offset a volume decline due partly to product pruning activity.

Operating profit in Developing Countries rose 55%, of which 5 percentage points were due to the LU acquisition. Pricing, a value-added tax credit in Brazil and favorable product mix helped drive profits upward. Sales were up 19%.

"Successful investments in chocolate and coffee drove significant volume and revenue growth across all key markets in the Eastern Europe, Middle East and Africa region," Kraft said. "Latin American growth was driven by pricing gains in biscuits in Venezuela, growth in chocolate and biscuits in Argentina."

Net income in the nine months ended Sept. 30 was $2,738 million, or $1.17 per share, up 37% from $2,005 million, or $1.15 per share in the same period in 2007. Net sales were $31,434 million, up 21%.

Looking forward, the company left its earnings forecast, excluding items, unchanged for the year at $1.88. The company reiterated its forecast of e.p.s. of $2 per share in 2009.

Expanding on the results and the outlook, Ms. Rosenfeld said both reflected a path the company set upon more than a year ago.

"We’ve invested to improve product quality and rebuild brand equity since 2007, and that has given us renewed pricing power," she said. "As a result, 2008 represents an important landmark. It will be the first year in many that Kraft will fully offset input cost inflation through a combination of pricing and productivity."

At the same time, Ms. Rosenfeld warned that the company could feel the effects of the credit crunch in the fourth quarter and has adjusted plans accordingly.

"We’ve done this because tight credit may lead some retailer inventory liquidation that could impact our fourth-quarter shipments and because changes in consumer sentiment and consumer spending remain a concern," she said.

This article can also be found in the digital edition of Food Business News, November 11, 2008, starting on Page 16. Click here to search that archive.

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