Kraft faces barbell burden

by Josh Sosland
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To discover why the food business is so challenging, W. Anthony Vernon said looking where consumers shop is a good place to find answers.

“Club and dollar stores are the only channels that are growing,” he said. “Think about that. Think of all the outlets in America, and traffic is only growing at club and dollar.”

Mr. Vernon, chief executive officer of Northfield, Ill.-based Kraft Foods Group, Inc., offered the observation as part of what generally was an upbeat assessment of his company’s prospects. He spoke with Wall Street analysts Oct. 30 after the company issued third-quarter financial results.

With those financial results, Kraft reaffirmed its earnings guidance for the year, and Mr. Vernon said the company remained confident in a five-point strategy of marketing, innovation, “good-better-best price value ladders,” low-cost manufacturing and a commitment to reinvesting 50% of cost savings into brand building.

“We continue to make progress,” he said. Evidence of improvement he cited was the percentage of the company’s business in which Kraft has gained market share. He said the figure has climbed to more than 50% in 2013, from 40% in 2012 and 34% in 2011.

“We remain confident that our disciplined approach to growing our brands and driving cost savings will enable us to continue delivering the consistent returns our shareholders expect,” he said.

During the call, Mr. Vernon drilled deeper into Kraft’s various businesses offering updates on progress made on a category-by-category basis. Still, the persistent difficulty of the consumer market and the important challenges that is creating for Kraft came up again and again during the call.

“During the third quarter, we witnessed the value consciousness of the consumer intensifying,” he said. “This looks to be driven by a combination of factors — a prolonged decline in the labor participation rate. The burden of higher payroll taxes. And continued erosion in consumer confidence. We are seeing shopper trips down overall, and especially down in the all-important stock-up trip. In fact, the only places where store traffic was up in the latest 52 weeks were in the club and dollar channels — amazing. And in the latest 13 weeks, store traffic was up only in dollar channels.

“With fewer trips, and even fewer large shopping trips, we see consumers with little interest or minimal ability to buy more than what they need for a given week. Or sometimes, a given day. And that’s translating into a decline in the lift we typically see from the incremental dollar of promotional activity.”

Attention to the so-called barbell economy, a squeeze on the middle class and pressure on lower income groups, has intensified since the 2008-09 recession. According to figures from the U.S. Bureau of the Census, mean income of the lowest two income quintiles rose 167% and 177% between the years 1980 and 2012. By contrast, mean income in the highest quintile climbed nearly twice as much, at 291%. For the top 5% of earners, income was up 358%. Over this same period, the overall consumer price index rose 179% (170% for food alone), meaning real income has been flat for the lowest 40% of earners over the past generation.

For his company, this environment “reinforces the importance of the Kraft playbook,” Mr. Vernon said, citing the five-point strategy.

“This is not an environment that we or our industry can expect to promote our way out of,” he said.

The manner in which the economic picture is intertwined with Kraft’s fate may be seen in the company’s Meals and Dessert’s segment. He said the company’s macaroni and cheese and Velveeta dinners businesses “have more than held their own in the face of a highly competitive environment.”

Describing the Velveeta dinner franchise as “big” and macaroni and cheese as “critical” for the company, Mr. Vernon said he was optimistic about the category’s prospects even in the face of intense competition.

“It has been a very competitive category that I honestly look at positively,” he said. “Because we and our competitors need to grow categories, not just trade share. So you’ve had some new formidable entries that have been well-supported, and you see market share jump around a little bit. You know we went at it with Hamburger Helper, with Velveeta. Now we are going at it with some of the offerings from some other people. This is a category that is critical to us and to the retailer. And I think you will see it hang in there. I still think it is very well-positioned in this market for — especially given a strapped consumer — because it offers real value through product quality, our marketing and our innovation to compete.”

Responding to a question, Mr. Vernon said Kraft will be affected by cuts in the Supplemental Nutrition Assistance Program and expressed support for SNAP.

“We share with the industry, the G.M.A. (Grocery Manufacturers Association), the belief that SNAP is an important tool in the fight against hunger,” he said. “And that it provides deeply needed assistance to American families who are struggling. It is very difficult to figure out what gets cut from SNAP and how it affects a family budget in our forecast.

“We do believe people have to eat. It remains critical for us in this environment to provide our good-better-best price value offerings in as many categories as possible. And to make sure that we are serving the needs of all American households, big and small, rich and poor.”

In the immediate future, Kraft expects to feel a pinch from the SNAP reductions and from the unusual timing of the holidays this year, Mr. Vernon said.

“This reduction in SNAP that has been talked about and is real, that starts basically right now,” he said. “And some have talked about this, and I think it is a factor that you can study, that the holidays are tighter, late Thanksgiving to Christmas, than they are six out of seven years. And that means one less paycheck for a lot of people. And one less paycheck in this environment is a big deal.

“Short term, wind is in our face. Nobody loves it, but we operate in it.”

Vernon picks six

While pleased with the progress Kraft Foods Group, Inc. has made rejuvenating most of its product lines, the company will not succeed if conditions do not improve for another half dozen key lines, said W. Anthony Vernon, chief executive officer of Kraft.

Mr. Vernon spoke Oct. 30 in connection with Kraft third-quarter earnings.

“The reality is, the percentage of our portfolio that has been rejuvenated is not yet at critical mass to offset the problem areas that remain,” he said. “As a portfolio company, we are unlikely to bat 1,000 and have everything moving in the right direction all at once. Right now in the U.S., 6 of our 17 largest franchises don’t yet have the fundamentals in place to drive industry-leading profitable growth. And as a result, our composite growth as a company is still running below the broader North American food and beverage market.”

Touching at least briefly on each of the six, Mr. Vernon said the dynamics and approach the company was taking differed for each. For example, in Jell-O, the company has launched a new campaign, is adjusting pricing and is working on the “cost side of the equation to pay for it all,” he said.

“Oscar Mayer cold cuts, which we have also talked about in the past, is improving sequentially, but needs more innovation and strategic pricing to get it back where it needs to be,” Mr. Vernon said. “We have the right team in place to do that.”

Expanding on the meat market, Mr. Vernon described a “tough cold cuts year” and illustrated the complex dynamics of the individual markets he was highlighting.

“I don’t want to miss the fact that it’s been a great bacon year,” he said. “It’s been a solid hotdog year. It’s been an incredible Lunchables year. All of those basically are lunch meat kind of franchises. What is going on in cold cuts is a very interesting phenomenon. And that is, a big competitor comes in — and I would name them Tyson, who grabs the low-end of the price point, a formidable one. We probably should have acted sooner. I said that. And importantly, great marketing by the deli competitors. And you know their names. I don’t want to give them too much credit.”

In ready-to-drink beverages, he said “packaging issues,” actively being addressed by the company, were keys to improving the business.

Turning to the categories of Kraft salad dressings and mayonnaise, Mr. Vernon did not offer a near-term solution to difficult market conditions.

“A recent price-based competition and our focus on profitable volume have held us back from making the level of brand equity investments that can grow the category and our businesses,” he said.

The Kraft powdered beverage business, especially Crystal Light, has been hurt from “cannibalization” from the company’s successful MIO drink platform, a development Mr. Vernon conceded had been “underestimated” by the company.

“Powdered beverages continue to provide a unique consumer proposition,” he said. “And we need to go back and rebuild support.

“The good news is that we have the firepower to re-invest and turn these businesses around. And that’s because our costs savings and productivity programs are fully on track.”
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