Kraft operating income climbs 39% in Q3

by Eric Schroeder
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NORTHFIELD, ILL. — Operating strength within all its U.S. units, and especially in convenient meals and beverages, led a 39% gain in overall operating income at Kraft Foods Inc. in the third quarter. Operating income in the quarter ended Sept. 30 was $1,419 million, up from $1,023 million in the same period a year ago. Net income for the quarter was down because of a large gain in the 2008 period from the sale of its Post cereal business.

The results prompted Kraft to raise its earnings-per-share guidance for 2009 to $1.97, up from an earlier forecast of $1.93 per share. The new guidance reflects strong year-to-date profit performance, as well as the company’s possible combination with Cadbury P.L.C, according to Kraft.

Third-quarter sales fell 6% to $9,803 million from $10,401 million. Looking ahead to the remainder of the year, Kraft cut its sales growth expectations to approximately 2% versus an earlier forecast of 3% growth. The company pointed to a lower contribution from pricing as a result of lower-than-expected £input costs, as well as a decision to forego unprofitable volume and weakening economic conditions in certain countries in Western and Eastern Europe.

Net income at Kraft Foods in the third quarter ended Sept. 30 totaled $824 million, equal to 56c per share on the common stock, down 40% from $1,362 million, or 91c per share, in the same quarter a year ago. Last year’s results included an $849 million gain on the sale of discontinued operations.

"We continue to build our operating and financial momentum despite the difficult consumer environment," said Irene Rosenfeld, chairman and chief executive officer. "Our volume/mix, profit margin and cash flow trends are strengthening as we successfully execute our growth plan. As a result, we expect to deliver higher earnings and cash flow in 2009, while further increasing our brand investments to drive future growth."

Commenting on the potential acquisition of Cadbury, Ms. Rosenfeld said Kraft will maintain a disciplined approach.

"Our criteria include accretion to cash e.p.s. in the second year, delivering a return on investment well in excess of our cost of capital, and maintaining both our investment grade credit rating and our dividend," she said.

Kraft Foods must announce a firm intention to make an offer for Cadbury, or instead state it does not intend to make an offer, by Nov. 9, according to a ruling from The Panel on Takeovers and Mergers, a London-based independent body that regulates takeover bids and other merger transactions for companies with registered offices in the United Kingdom.

In a Nov. 3 conference call, Ms. Rosenfeld said "there is not much new to say" regarding Cadbury. Reviewing the steps Kraft was taking ahead of the Nov. 9 deadline, she concluded by emphasizing Kraft’s fate does not rest on successfully completing the acquisition.

"With or without Cadbury, Kraft Foods is well positioned to deliver top-tier performance," she said.

Considerable discussion in the conference call revolved around challenges Kraft was encountering in efforts to build top-line growth. Elaborating on what she estimated as 0.5% organic top-line growth in the quarter, Ms. Rosenfeld said the figure was brought down by strategic "pruning" of less profitable product lines (reducing top-line growth by 1 percentage point), lowered prices to reflect the impact of lower dairy costs (reduced growth 1.6 points) and difficult comparisons because of a highly successful merchandising program in 2008 with a key customer.

"Considering all of these factors, our organic top-line growth would have been almost three points higher," she said. "Importantly, our top-line results continued to reflect the transition from growth based on price to growth based on volume and mix."

Looking broadly at Kraft’s U.S. business, Tim McLevish, executive vice-president and chief financial officer, acknowledged that market share performance "continues to be challenged." While he said 52-week figures are the best measure of share performance and that these figures are not what the company hopes going forward, nearer term measurements are hopeful.

"The latest 13-week data indicate we are picking up momentum and the improvement trend is strong," he said.

Asked whether the company’s long-term target of 4% sales growth was achievable, Ms. Rosenfeld was optimistic.

"We continue to feel quite comfortable that the 4% plus target for revenue growth is the right target to lay out, and if you look even at these last two years, that we’re at 4%," she said. "In any given year we’re not going to necessarily hit the number precisely. But we feel quite comfortable that given the investments that we have made in our brand equities, the appropriate pruning that we have done of products and product lines that were actually a drag on our mix, that we are well staged to be able to continue to drive 4% growth on a sustainable basis."

Operating income of Kraft’s U.S. Grocery business was $258 million, up 9% as the benefits of improved alignment of prices with input costs more than offset incremental investments in marketing. Sales in the unit fell 3% to $778 million, reflecting the planned discontinuation of less-profitable product lines and the timing of a merchandising program.

"These factors more than offset solid growth from investments behind Kraft mayonnaise and Miracle Whip spoonable dressings and Jell-O dry packaged desserts," the company said.

Operating income of U.S. Convenient Meals climbed 61% to $127 million, boosted by a 5% gain in sales to $1,135 million. The company attributed growth in sales to double-digit growth in pizza and Oscar Mayer Deli Fresh meats. In addition, incremental investments in value-oriented consumer programs drove more than 20% growth in DiGiorno pizza.

Operating income in the U.S. Cheese division rose 12% to $166 million behind the benefits of improved volume/mix. Sales in the unit, meanwhile, fell 10% to $824 million.

In U.S. Snacks, operating income rose 3% to $196 million. Sales fell 3% to $1,232 million, as solid volume/mix gains in core biscuit brands and snack nuts were offset by a decline in bars and the timing of a merchandising program versus the prior year. Kraft said net sales in its top five biscuit brands rose approximately 5%.

Ms. Rosenfeld said biscuit sales were adversely affected by pricing decisions.

"In response to the drop in wheat, we executed (pricing) actions through promotions changes as opposed to list price reductions," she said.

Operating income in the U.S. Beverages business rose 61% to $133 million on a 2% gain in sales to $754 million.

"The increase in net revenue was driven by solid growth in Capri Sun ready-to-drink beverages, Kool-Aid and Country Time powdered beverages as well as Starbucks and Maxwell House coffees," Kraft said.

For the nine months ended Sept. 30, net income was $2,311 million, or $1.56 per share, down 15% from $2,706 million, or $1.78 per share, in the same period a year ago. Net sales were $29,361 million, down 6% from $31,251 million. Operating income in the nine months totaled $4,218 million, up 20% from $3,513 million in the first nine months of fiscal 2008.

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