Packaged Food: We expect sales growth to increase slightly going forward. We expect operating margins to expand going forward.
The U.S. Packaged Foods sector expanded gross margins by 70 – 100 basis points annually during the ’80s & ’90s and by 45 bases points from ’00 – ’03, until the wave of input cost inflation that hit in 2003.
The U.S. packaged food group looks much more attractively valued today than it was in the fall of 2008.
Kraft: Outperform; target price of $37. Kraft’s gross margins declined by 155 basis points per year in 2004/5 as commodity costs rose by more than $800 million per annum and then fell again in 2007 as dairy prices spiked.
Today, we are just starting to see the benefits of easing commodity costs on margins, especially as dairy prices roll over.
Moreover, a recovery in beverages and the EU is coming through now that the Tassimo [hot-beverage system] strategy has been revised. Over time, we believe that Kraft can improve its operating margins from 12.3% in 2008 to over 16% as margins normalize in U.S. beverages, U.S. cheese and Europe.
Volume/mix growth has been sluggish as of late, but we believe an improvement is imminent given: Increasing promotional spending and list-price reductions in select categories; lapping the anniversary of SKU reductions and elimination of inefficient trade promotional spending; and higher marketing spending in key categories as commodity pressures ease.
Campbell Soup: Outperform; target price of $41. Overseas, Russia and China hold huge potential for growth, given that the two account for more than 50% of today’s global soup consumption.
An improvement in organic growth appears imminent in fiscal year ’10, particularly given promotional activity as well as the re-launch of Chunky soup with a healthier focus. In the near-term, margins should start to benefit from slowing commodity cost inflation (from 7-8% seen in fiscal year ’09 down to 2-3% in fiscal year ’10) as well as productivity improvements.
Moreover, we believe that the “premiumization” of the soup category should benefit the company in the U.S. once the U.S. consumer recovers.
Kellogg: Outperform; target price of $62. Kellogg has the strongest portfolio in the U.S. Food group given its strong market shares, its participation in high-margin categories, its strong track record on brand support and innovation, and its successful integration of large- and small-scale acquisitions in recent years.
Kellogg has an earnings growth engine in Latin America, where it maintains higher margins (~20%) than in its core U.S. business (~17%). There, there is ample room for cereal growth as well as the opportunity to piggy-back snacks into the market on top of existing cereal distribution infrastructure.
We are likely to see substantial margin recovery ahead of conservative management guidance given commodity cost pressures are easing and productivity improvements are kicking in.
We [also] rate Dean Foods: Outperform; with a target price of $26.