MDLZ - Mondelez

[jay21]

Background: Kraft recently split into two divisions: a grocery business with higher developed market exposure (Kraft Food Group) and a snacks business with higher developing market exposure (Mondelez).  I believe that there is an opportunity in Mondelez due to a higher sales growth rate and potential margin expansion.

 

Sales Opportunity: According to Kraft’s 2011 10-k, the Krafts Foods Developing Market segment constituted 26.9% of sales.  44% of sales will come from developing markets for Mondelez.  This should contribute significantly to increasing the rate of sales growth. 

 

Another reason for an increased rate of sales is the change in product mix and the high product quality.  Biscuits (Oreos, Chips Ahoy, Ritz), chocolate (Milka, Cadbury, Toblerone), and gum (Trident, Stride, Chiclets) constitute roughly 75% of sales for Mondelez.  These are higher growth categories than some of the grocery segment that went to Kraft Food Group, which include brands such as Kraft, Oscar Meyer, and Velveeta.  The quality of brands at Mondelez is also very high as evidenced by the high market shares of each segment.  Mondelez has the #1 market share position for biscuits and chocolate and #2 for gum.

 

Management has guided towards a long term growth rate of 5 - 7% for organic net revenue growth.  Based upon these factors,I believe this is attainable.

 

Margin Expansion: There is also room for sizeable margin expansion.  From 2009 to 2011, Mondelez’s gross margin has ranged from roughly 36.75% to 37.7% and its EBITDA margin has ranged from roughly 8.7% to 12.2%.  This compares negatively with Nestle, a multinational food company with similar developing market exposure, whose gross margin has ranged from roughly 47% to 50% and EBITDA margin has ranged from roughly 15.5% to 17% over the last two years.  I think that Mondelez can significantly increase its gross margin.  Some of this savings may be/should be reinvested into the business in the form of advertising and other value creating expenses.  After gross margin savings and incremental increases value creating expenses, I believe that Mondelez is capable of 14 to 15% EBITDA margins.  Using the 2011 financials as a base, EBITDA margins of 14 to 15% imply an earnings before taxes range of $3.49 billion to $3.85 billion.  This would equate to an increase of 22% to 35% over the reported earnings before taxes of $2.85 billion.

 

Valuation: Given the uncertainty of when and if the company will increase margins, the valuation of this company can be difficult.  The company has a decent amount of leverage which will cause the sales increase range of 5 to 7% to have a larger impact on earnings (I calculated this will cause earnings to raise from very high single digits to low teens double digits).  In my opinion a company with this growth should be worth somewhere between 20 to 30 times earnings.  The company currently trades for roughly 19 times 2011 earnings.  By paying under 20 times earnings, I think you are allowing for some multiple expansion and getting the margin expansion opportunity to free.

 

Risks: The biggest risk I see is a poor acquisition by the management.  The purchase of Cadbury with undervalued stock and the sale of the DiGiorno business were probably not the best acquisitions given the price.  However, I believe the products of Cadbury fit nicely with this new business and offer a higher sales growth opportunity. Given the amount of debt the company currently has, I would think that the company would be less inclined to make a major purchase. 

 

Overall: I believe Mondelez offers the opportunity to buy a company with high quality brands at an attractive price.  The risk reward is skewed given this company should not be valued at a significantly lower multiple, limiting downside. Margin expansion, coupled with sales growth, can cause earnings to grow at a tremendously high rate offering a lot of upside.

[Guest rimm_never_sleeps]

$46b market cap. 2% div yield and 16 p/e on next year's earnings. good company. but I don't see the undervaluation.

[bmichaud]

Background: Kraft recently split into two divisions: a grocery business with higher developed market exposure (Kraft Food Group) and a snacks business with higher developing market exposure (Mondelez).  I believe that there is an opportunity in Mondelez due to a higher sales growth rate and potential margin expansion.

 

Sales Opportunity: According to Kraft’s 2011 10-k, the Krafts Foods Developing Market segment constituted 26.9% of sales.  44% of sales will come from developing markets for Mondelez.  This should contribute significantly to increasing the rate of sales growth. 

 

Another reason for an increased rate of sales is the change in product mix and the high product quality.  Biscuits (Oreos, Chips Ahoy, Ritz), chocolate (Milka, Cadbury, Toblerone), and gum (Trident, Stride, Chiclets) constitute roughly 75% of sales for Mondelez.  These are higher growth categories than some of the grocery segment that went to Kraft Food Group, which include brands such as Kraft, Oscar Meyer, and Velveeta.  The quality of brands at Mondelez is also very high as evidenced by the high market shares of each segment.  Mondelez has the #1 market share position for biscuits and chocolate and #2 for gum.

 

Management has guided towards a long term growth rate of 5 - 7% for organic net revenue growth.  Based upon these factors,I believe this is attainable.

 

Margin Expansion: There is also room for sizeable margin expansion.  From 2009 to 2011, Mondelez’s gross margin has ranged from roughly 36.75% to 37.7% and its EBITDA margin has ranged from roughly 8.7% to 12.2%.  This compares negatively with Nestle, a multinational food company with similar developing market exposure, whose gross margin has ranged from roughly 47% to 50% and EBITDA margin has ranged from roughly 15.5% to 17% over the last two years.  I think that Mondelez can significantly increase its gross margin.  Some of this savings may be/should be reinvested into the business in the form of advertising and other value creating expenses.  After gross margin savings and incremental increases value creating expenses, I believe that Mondelez is capable of 14 to 15% EBITDA margins.  Using the 2011 financials as a base, EBITDA margins of 14 to 15% imply an earnings before taxes range of $3.49 billion to $3.85 billion.  This would equate to an increase of 22% to 35% over the reported earnings before taxes of $2.85 billion.

 

Valuation: Given the uncertainty of when and if the company will increase margins, the valuation of this company can be difficult.  The company has a decent amount of leverage which will cause the sales increase range of 5 to 7% to have a larger impact on earnings (I calculated this will cause earnings to raise from very high single digits to low teens double digits).  In my opinion a company with this growth should be worth somewhere between 20 to 30 times earnings.  The company currently trades for roughly 19 times 2011 earnings.  By paying under 20 times earnings, I think you are allowing for some multiple expansion and getting the margin expansion opportunity to free.

 

Risks: The biggest risk I see is a poor acquisition by the management.  The purchase of Cadbury with undervalued stock and the sale of the DiGiorno business were probably not the best acquisitions given the price.  However, I believe the products of Cadbury fit nicely with this new business and offer a higher sales growth opportunity. Given the amount of debt the company currently has, I would think that the company would be less inclined to make a major purchase. 

 

Overall: I believe Mondelez offers the opportunity to buy a company with high quality brands at an attractive price.  The risk reward is skewed given this company should not be valued at a significantly lower multiple, limiting downside. Margin expansion, coupled with sales growth, can cause earnings to grow at a tremendously high rate offering a lot of upside.

 

 

Don't forget they have approximately $2.83 in excess cash per share (total cash of $5.4B minus 1% x sales of $35B) and high-cost debt that currently trades well below its cost of 5.75%.

 

MDLZ is a prime candidate for a special dividend and/or large buyback announcement....too bad they are run by dumb-ass management that is focused on making the world a "sweeter" place.

 

 

 

Long MDLZ

[jay21]

$46b market cap. 2% div yield and 16 p/e on next year's earnings. good company. but I don't see the undervaluation.

 

The undervaluation depends on what growth rate and margin expansion you think is possible.  Also, I think these kinds of companies have severely limited downside so it's a good risk/reward.

[biaggio]

MDLZ seems like a 2 leg stool

 

-great products/brands (personally love them)/profit, etc

-fairly priced or decent valuation for great business

-missing leg is management/questionable capital allocation

 

I would be interested in buying at <$22 (15X earnings)-maybe unrealistic

[Guest rimm_never_sleeps]

$46b market cap. 2% div yield and 16 p/e on next year's earnings. good company. but I don't see the undervaluation.

 

The undervaluation depends on what growth rate and margin expansion you think is possible.  Also, I think these kinds of companies have severely limited downside so it's a good risk/reward.

 

i don't know how you could say that about the downside. it could easily go down 25% if the market corrected 35%. berkshire (one of the most stable businesses in the world) dropped 50% in the 2008 market debacle.

 

this is the kind of stock I would visit after a huge market correction. but basically you've had a strong stock market, kraft has had the spotlight on it by wall street for over a year as they waited for the spin off. it's also the one money managers want to own because it is the fast growing one---the "sexy" one. it has tons of coverage from the sell side. management is suspect.  so I don't see how you can get an analytic edge. the bull case is well known and "depends" on things. having said that, you could do much worse than owning this company. I just think value investors who can invest in smaller or mid cap, less well known companies will be far better served there.

[jay21]

$46b market cap. 2% div yield and 16 p/e on next year's earnings. good company. but I don't see the undervaluation.

 

The undervaluation depends on what growth rate and margin expansion you think is possible.  Also, I think these kinds of companies have severely limited downside so it's a good risk/reward.

 

i don't know how you could say that about the downside. it could easily go down 25% if the market corrected 35%. berkshire (one of the most stable businesses in the world) dropped 50% in the 2008 market debacle.

 

this is the kind of stock I would visit after a huge market correction. but basically you've had a strong stock market, kraft has had the spotlight on it by wall street for over a year as they waited for the spin off. it's also the one money managers want to own because it is the fast growing one---the "sexy" one. it has tons of coverage from the sell side. management is suspect.  so I don't see how you can get an analytic edge. the bull case is well known and "depends" on things. having said that, you could do much worse than owning this company. I just think value investors who can invest in smaller or mid cap, less well known companies will be far better served there.

 

I disagree about it being "the sexy one" and being owned by money managers.  KRFT and MDLZ trade at nearly identical forward P/E's.  You could make the argument that KRFT is the one people own because of its high payout.

 

Also, I disagree a lot with people saying you can't have analytic edge or have any outperformance owning these kinds of stocks.  Look at PG, they have been well known for years and continue to outperform.  It appears to me that the market is pricing the stock with a 5% growth rate (10% discount and a 5% growth is a 20 multiple).  I think that the growth rate is higher.  Therefore, its underpriced.

 

I do agree that there are better opportunities out there and under most of the scenarios I envision, this one may not clear people's hurdle rates.  But I am constructing my portfolio to have about half in high-quality, compounders.  This fits the bill.  It's a small position now, but can go higher if the multiple continues to drop.

[jay21]

Ackman's presentation on Kraft from 2010

 

http://www.marketfolly.com/2010/02/bill-ackman-pershing-squares-kraft.html

[Shane]

Seems fairly valued to me.  I'd start paying attention at less than $24, might be able to deliver 10%+ returns at that price.

[boilermaker75]

Enterprise value of $72.31 billion and a free cash flow of $3.311 billion. Is this not buying dollars for $1.50-$1.80?

[Palantir]

Seems fairly valued to me.  I'd start paying attention at less than $24, might be able to deliver 10%+ returns at that price.

 

Hey on this point, out of curiosity, what is your methodology for predicting expected return here?

 

What I do is, I just project FCFE for about 40 years, and find the discount rate that generates the market price, and that discount rate is my expected return....

[Shane]

Palantir - I simply took a 5 year FCF projection and multiplied that by the current multiple to get a FV, then discounted back to find expected return.

 

A 40 year projection seems ambitious to me.

[ourkid8]

There are numerous buttons Irene can push to further enhance shareholder value.  I feel this stock is valued to slightly undervalued based on the below potential catalyst and operational efficiencies: 

 

-10% of revenue is derived from Cheese and Grocery and I am hoping they put this up for sale as their focus should be on the fast growing snack categories. (Biscuits, Chocolates, Gum and Candy and Beverages) 

-Further drive efficiencies by lowering procurement costs / overhead as a percentage of revenue and expansion of gross margins

-improving balance sheet by lowering interest rate in this low rate environment and spreading out payment dates

-small tuck-in acquisitions (I want to emphasize small) in their snack category to leverage their scale and quickly ramp-up sales through their very strong distribution network

-BRIC / Next Wave economies is under-penetrated and high margin snacks allows years of growth ahead of it

-Share repurchase program when the stock is selling below intrinsic value with their cash they have on hand

 

 

[biaggio]

http://www.marketwatch.com/story/mondelez-grants-ceo-10-mln-special-equity-award-2012-12-21

 

This is the reason I will probably stay away as long as current leadership remains- If Irene needs to be incentivised then make her put $10 million of her own money into the company.

[jay21]

Not familiar with Peltz:  http://www.reuters.com/article/2013/03/22/mondelez-pepsico-idUSL1N0CE3UQ20130322?feedType=RSS&feedName=hotStocksNews&rpc=43

 

Anyone know anything about him?

[CorpRaider]

Peltz is (generally) an activist investor who is generally associated with the food and beverage industry.  I think he controls wendy (arby's) group and maybe Dr. Pepper Snapple group.  He bought snapple from quaker and flipped it to cadbury in the 90's for a couple billion.  I saw that he recently took a big stake in Legg Mason, so maybe he's getting away from the food industry.  I like DPS but it never gets cheap enough, probably because of all the diet dr pepper's I drink.  I'm like forest gump with those things.

 

[Phaceliacapital]

I think he also has a stake in Danone (french yoghurt company)

[ourkid8]

http://finance.yahoo.com/marketupdate/inplay#mdlz

 

In an amended 13F out Friday after the close, Bill Ackman's Pershing Square disclosed owning 5,978,214 shares (sole and shared) as of 12/31/12.  Pershing did not report owning any MDLZ in its prior filings.

 

[jay21]

http://finance.yahoo.com/marketupdate/inplay#mdlz

 

In an amended 13F out Friday after the close, Bill Ackman's Pershing Square disclosed owning 5,978,214 shares (sole and shared) as of 12/31/12.  Pershing did not report owning any MDLZ in its prior filings.

 

Thanks for the info.  He has owned Kraft before the split that sold after it ran up some.  I think I posted his presentation earlier.

[Guest wellmont]

Pershing did not report owning any MDLZ in its prior filings.

mdlz was not a report-able security until q4 2012.

[bmichaud]

This is just phenomenal stuff. Love corporate restructurings/financial engineering!

TRIAN-White-Paper-PepsiCo.pdf

[Ross812]

Interesting,

 

I was just researching Ingersoll Rand (IR) who owns Trane and American Standard HVAC, Club Car golf carts, Slage locks, and several other well known brands. Trian Partners bought a large stake in IR at the end of last year and Peltz took a seat on the board. Trian has facilitated a spin-off of IR's security segment (Q3'13), raised the dividend (Q1'13), and initiated a 2B (I think) buyback by the end of 2014. It seems Trian is trying their hand outside of the food industry. 

[CorpRaider]

This is just phenomenal stuff. Love corporate restructurings/financial engineering!

 

He's a beaut.  I followed him into Wendy's-Arbys back in the day, but I didn't hang in there long enough to make any money. 

[cogitator99]

I think the value of MDLZ lies in its brands -- some of the best brands in the F&B space. These are brands that are likely to be around 20, 30 years from now. Whether or not you believe Trian's values, it seems to me that the brands are enormously valuable.

 

There's probably something to the thought that sustainable cash flow can be used to lock in low-cost leverage as is available currently...similar what is being done @ HNZ. Over the longer-term, MDLZ's brands probably confer pricing power as well.

 

It's not without hair though. You can look at those margins and either think of it as a weakness or an opportunity. 

[jay21]

I think the value of MDLZ lies in its brands -- some of the best brands in the F&B space. These are brands that are likely to be around 20, 30 years from now. Whether or not you believe Trian's values, it seems to me that the brands are enormously valuable.

 

There's probably something to the thought that sustainable cash flow can be used to lock in low-cost leverage as is available currently...similar what is being done @ HNZ. Over the longer-term, MDLZ's brands probably confer pricing power as well.

 

It's not without hair though. You can look at those margins and either think of it as a weakness or an opportunity.

 

I think margin expansion is a definite opportunity.  Cadbury I believe has a large % of sales from Europe so some of that opportunity lies in waiting for Europe to turn so they can get some price increases there.  Obviously, there are some other opportunities that are uncorrelated to the economy, but those depend on management execution, which is probably the weakest part of the thesis.  I hope with Peltz meeting with management he gets them focused on this area.