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Kraft's revenue soars but earnings suffer from higher costs

by Benjamin Miraski
April 30, 2008


Kraft Foods Inc. posted earnings lower than the year-prior quarter because of higher input costs and despite stronger net revenues. However, the company beat analysts’ expectations by three cents sending the stock 2.8 percent higher in Wednesday trading.

For the quarter ended March 31, the Northfield-based food processor, with brands such as Jell-O, Oreo and Maxwell House, reported net income of $608 million, or 40 cents per diluted share. Earnings were 13.4 percent lower than earnings in the year-prior quarter of $702 million, or 43 cents per diluted share.

Excluding items, the company earned $681 million or 44 cents per diluted share. This was 4.9 percent lower than the same quarter of the previous year, when the company earned $716 million, excluding items, or 44 cents per diluted share.

Wall Street estimated diluted per-share earnings excluding items at 41 cents per share, as compiled by Zacks Investment Research Inc.

The company’s equity base was reduced from the same period a year ago because of an ongoing share repurchase program. Average diluted shares outstanding were reduced by 102 million shares from the same quarter last year. The year-ago period also benefited from a one-time interest benefit of 3 cents per share related to Kraft’s separation from Altria Group Inc.

Net revenues in the first quarter were $10.4 billion, up 20.8 percent from the same period in the year prior when net revenues were $8.6 billion.

Kraft continues to deal with higher input costs related to commodities across the board. However, the company said it is combating those costs by raising prices on products as it continues to reinvest in its brands.  On Wednesday's conference call, CEO Irene Rosenfeld said she is optimistic about the impact of the moves that Kraft is making.

“Our ability to increase prices and increase market share is proof positive that our investment is paying off,” she said.

Matt Arnold, an analyst who covers the company for Edward D. Jones and Co. LP, agrees that the pricing strategies are important.

“It is a key piece of it, absolutely,” Arnold said. “The pricing they are taking alone isn’t enough to offset the inflation they are seeing in input costs.”

Despite what Rosenfeld termed “aggressive” pricing strategies, Kraft’s margins were lower in the quarter. The company’s gross margin declined by 1.9 percent to 33.6 percent and operating margin was down 1.9 percent to 11.2 percent.

Margin erosion was strongly felt in the U.S. snacks and cereal business, an area where the company had historically strong performance according to David Driscoll, an analyst who covers the stock for Citigroup Inc.

Operating margin in the segment was 11.7 percent in the first quarter, down from 16.8 percent in the year-prior period. Operating income in the segment fell 28.2 percent from $234 million to $168 million.

“Clearly we are not pleased with the Q1 performance of our snacks and cereals business,” Rosenfeld said.  She added that the issues with margin were due to a major run-up in the cost of wheat, which surpassed what the company was expecting.

“This is a tough one to swallow here,” Driscoll said to conclude his comments on the earnings call.

According to the company’s management, the full impact of pricing changes will start to be seen in the second quarter, and will be complete in the second half of the year. This is based on the price increases lagging behind the rise in costs, and some price points being protected for large events that occurred in the first quarter, such as the Super Bowl and Easter.

Rosenfeld continued her positive spin looking ahead as consumers move away from eating out at restaurants and eat more of their meals at home.

“We feel comfortable that as consumers eat home more often, they will come home to Kraft,” she said.

“The single biggest key to success, and where we see opportunity, is to improve profitability in the U.S. business,” Arnold explained.  He added that the company continues to make investments in their iconic brands and that there is a lot of opportunity to improve domestic profitability.

Kraft projected that its full-year earnings per diluted share will be $1.56, down from the full-year earnings of $1.62 per diluted share in 2007. Excluding items, the company is estimating $1.90 per diluted share. Analysts’ consensus excluding items is $1.89 per share as compiled by Zacks.

The forecast includes the impact of the acquisition of Group Danone SA’s international biscuit operations, but does not include the impact of the pending sale of the Post cereals business to Ralcorp Holdings Inc. When asked for guidance on the impact of the Post sale, Timothy McLevish, chief financial officer of Kraft, said the company would wait to comment until the transaction is completed.

Kraft Foods stock closed Wednesday at $31.63, up 86 cents from the previous day’s closing price of $30.77