Are Kraft’s Stocks a Buy Amidst the Spin-Off?

On August 14, 2012 Kraft’s (NYSE:KFT) Board of Directors announced the spin-off of its North American operations into a separate company which will begin trading on the NASDAQ under the symbol KRFT beginning October 1.  Existing shareholders will get one hundred shares of the new North American company for every three hundred Kraft Foods shares currently held. The remainder of existing Kraft operations will emerge in a company called Mondelez International Inc.beginning its trading life with the ticker symbol MDLZ.  Existing shareholders of KFT will get 300 shares of MDLZ for every 300 shares of KFT, thus emerging from the split owning both entities.

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On September 14, the Dow Jones Indices announced that United Health Care (NYSE:UHC) would replace Kraft as a component of the DJIA (Dow Jones Industrial Average) with the smaller size of the spin-off Kraft company cited as a reason for the change.

So, now we have a US focused Kraft and an internationally focused Mondelez.  So what’s the play here?  Is this new KFRT a BUY, a WAIT and SEE, or a STAY AWAY? Or, should new investors bet on the bigger entity MDLZ?

Let’s analyze the existing KFT with the relevant sections of our CHEAT SHEET investing framework.

C = Catalyst for the Stock’s Movement

Funds indexed to the DJIA will have to begin adding United Health Care after the switch becomes official on the 24 of September.  A significant sell-off of Kraft shares is a very real possibility and could drive down the share price substantially.  This could present a potential buying opportunity for investors looking for the kind of stability and dividend income the newly constituted Kraft Foods Group of North America will offer.

Historically there is some evidence that spin-offs from mammoth corporations do well. Existing institutional investors will own both companies but may increase or decrease holdings in one in favor of the other.

H = High Quality Pipeline

Kraft introduced 70 new products in 2012.  Kraft’s current rank on the Forbes list of the world’s most innovative companies is 63, up from 82 in 2011.  New products contributed 10% to total revenues in 2011, compared to 9% in 2010. Recent successful new products include MiO water enhancer, belVita breakfast biscuits, and Philadelphia Indulgence cream cheese products.

E = Equity to Debt Ratio is Close to Zero

The debt to equity ratio of 0.73 is somewhat high but difficult to gauge without digging into the financials to determine which operating segments are responsible for the debt.  However, compared to some of its major competitors, the existing KFT does not look too bad.  Nestles (OTC:NSRGY) has a debt to equity ratio of  0.43, while PepsiCo (NYSE:PEP) shows 1.20.

A = A-Level Management Runs the Company

If you believe bold moves are a sign of excellent management, Kraft is for you.  The maturity of Kraft’s North American markets was a cause for concern among some analysts.  Kraft North America total revenues dropped from about 60% of total revenue for Fiscal Year 2009 to around 54.7% for FY 2011.  In contrast, Kraft Europe and Kraft Foods Developing Markets went from 31.5% of KFT’s total revenue in 2009 to 45.3% in 2011.

With the split you have one company poised for growth and another with a stable revenue base which will return higher dividends to investors. The key for the new North American operation is the higher margin grocery business.  In the short term, investors should watch how the company handles the costs and timing of restructuring efforts as they will have some impact on earnings and profitability.

T = Technicals on the Stock Chart are Strong

Kraft technicals going into the split were strong. As of the close of trading on September 21st 2012 the stock price is 2.5% above its 20 Day Simple Moving Average; 3.95% above the 50 Day SMA; and 9.49% above the 200 Day SMA.  The stock price moved above the 200 Day SMA in October of 2011 and has remained above ever since.  There have been occasional dips below the other two averages but the stock price has remained in an upward trend year over year.

S = Support is Provided by Institutional Investors & Company Insiders

Kraft Foods is currently 73.88% institutionally owned.  The top five holders are Capital Research Global Investors, Vanguard Group, Berkshire Hathaway, Capital World Investors, and BlackRock Institutional Trust. As indicated, there may be movement either way from institutional investors with the emergence of two separate companies.

E = Earnings Are Increasing Quarter over Quarter

Kraft Foods has shown modest EPS growth for the last four quarters, from $0.52 to $0.55, with 4.55% growth Quarter over Quarter in the most recent reporting period. 

Conclusion

For investors willing to tolerate current market volatility, both KRFT and MDZ merit a BUY depending on investing preference – growth or income and dividend stability.  Investors with low risk tolerance and those looking for potential bargains may adopt a WAIT and SEE posture to see how things shake out with institutional investors.

Using a solid investing framework such as this can help improve your stock-picking skills. Don’t waste another minute — click here and get our CHEAT SHEET stock picks now.