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Kraft Foods Inc. Equity Valuation and Analysis Valued at November 1, 2006
KFT- NYSE $34.36 52 Week Ranges $27.44-$36.67 Revenue (2005) $34,113 Mil. Market Capitalization $57.614.5 Mil. Shares Outstanding 1,670,000,000 Dividend Yield 2.87% 3-Month Avg Daily Trading Volume 2,799,040 Percent Institutional Ownership 84% Book Value Per Share (mrq) $17.72 ROE 8.89% ROA 4.57% Est. 5 Year EPS Growth Rate 1% Cost of Capital Est. R2 Beta Ke
Kraft products can be purchased in over 150 countries around the
world. Its major market segments are the United States, Western
Europe, Latin America, and Canada. Kraft has currently 207
facilities world wide. (Kraft 2005 10K)
Over the last five years, Kraft’s annual sales volume growth has been .5%, while Kraft’s
main competitors Sara Lee and ConAgra Foods Inc. have had annual sales volume
growth of 1% and -13% respectively. The industry average is a -12% over the last five
years, proving that Kraft is a strong member in terms of sales growth in the diversified
major foods industry.
From 2001-2005, Kraft’s earnings growth has been 9% on an annualized basis, while
Sara Lee and ConAgra Foods Inc. has been .5% and -2% respectively. The industry
average is -1.5% and again Kraft proves a leader in the diversified foods industry.
(Kraft Value Line; November 3, 2006)
Kraft has a market capitalization of $58.4 billion dollars, making it a large cap company.
Kraft’s total assets over the last five years average around $58 million dollars. Over the
last five years, Kraft’s stock price has fluctuated to around $40 and has dropped to as
low as around $27. As of November 1, 2006 the price was $34.36.
(www.yahoo.finance.com)
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Industry Overview and Analysis
Five Forces
Competitive Force 1: Rivalry Among Existing Firms
Rivalry among existing firms already in the industry is the main influence of the average
level of profitability. Some industries compete aggressively on price, while others
compete on non-price elements, such as brand image.
Competitors Moderate
Threat of New Entrants Low
Substitute Products Relatively High
Customer Power High
Supplier Power Low
In the major food industry, Kraft Foods is the world’s second largest food and beverage
company. Their brand portfolio is very well known with more than 50 brands including:
Maxwell House, Milka, Oscar Mayer, Philadelphia, and Post. Since Kraft is one of the
strongest packaged foods company, there is only moderate competition between the
main competitors. Kraft realizes that they cannot fully compete on price within the
industry, but on other elements like brand image and loyalty. (www.kraft.com)
Kraft has worked hard to diversify their products from other firms in the industry, such
as focusing on value added products and starting to capitalize on the national trend of
healthy eating. By diversifying their products, Kraft reduces their switching costs in the
industry.
By customers continuously buying Kraft products, brand loyalty has affected the
company in a positive way. Kraft is making better use of their assets to generate
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savings to reinvest in brand building which ultimately increases switching costs for
consumers.
Competitive Force 2: Threat of New Entrants
New Entrants may want to enter into an industry to earn greater profits. However, the
ease with new firms entering into the industry is a key element of profitability.
New entrants into the major food industry face a hard time competing within this large
economy of scale. Kraft alone competes in seven different business segments: North
America Beverages, North America Cheese and Foodservice, North America Convenient
Meals, North America Grocery, North America Snacks and Cereals, European Union, and
Developing Markets, Oceania and North Asia.
Since Kraft was one of the first major food industries they set the standard and
developed the first mover advantages. For example their brand loyalty has increased
the switching costs which make it difficult for other companies to compete in this
industry. New Entrants have a very difficult time contending with the existing
relationships that have already developed within the industry.
Competitive Force 3: Threat of Substitute Products
The food industry has a fairly high threat of substitute products. These threats exist
because of the price gaps between store bought products and privately labeled
products. For example, Kraft macaroni and cheese may sometimes struggle with Great
Value macaroni and cheese because of a price difference. If consumers believe these
products are similar, then they often substitute one for the other depending on the
cheaper price. However, customers that are not concerned with the price of the item
will choose Kraft because of the higher quality taste of a premium product.
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In the food industry, companies often compete with its substitute products during a
recession within the economy. For example, during these slow times, consumers tend
to purchase store brand salad dressing instead of Kraft in order to save money. During
slow revenue generated periods, Kraft can increase their advertising spending and their
efforts to narrow adverse price gaps. Even though substitute threats exist, Kraft is still
one of the largest food manufacturers and will continue to grow.
Competitive Force 4: Bargaining Power Buyers
There are two factors that affect the powers of buyers: price sensitivity and relative
bargaining power. Major food industry buyers are more price sensitive because their
products are undifferentiated. For example the packaging for Kraft salad dressing
containers represent a large portion of the buyer’s costs. If these packaging costs
increase, then Kraft may shop for lower cost alternatives.
Relative bargaining power is another aspect to determine the bargaining power of
buyers. Consumers have a higher bargaining power than major food industries because
they can decide whether or not to buy their products. In return, the industry has the
lower bargaining power because consumers cause a greater threat to the companies by
not doing business with them.
Competitive Force 5: Bargaining Power of Suppliers
Bargaining power of suppliers directly relates to the bargaining power of buyers. Thus,
suppliers have very little bargaining power. Due to the large amount of substitutes
available to their customers it makes it difficult for suppliers to compete and gain
power.
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Value Chain Analysis
Having and maintaining a competitive advantage in an industry is vitally important to a
company’s success. To achieve competitive advantage the company must have
strategies that allow them to create value for the firm. There are several factors and
strategies that allow the company’s within the industry a competitive advantage. The
most important for all companies including Kraft is the relationship with their
consumers. All the firms within our industry take great pride in trying to build superior
customer brand value. They achieve the advantage by giving more product benefits to
the consumers. With the high level of competition, every firm competes on prices.
Quality of food and packaging is also very important in creating an advantage. Kraft is
extremely good in all these areas. This is reflected by them being one of the leaders in
the industry. Kraft’s wide variety of helpful services along with the strong brand image
keeps consumers satisfied and willing to buy Kraft products time and time again.
The relationship with trade partners is also very important. Having the same trade
partner for years can become quite an asset to a company. It can help drive down
costs and raise profits. This will also allow companies to pass even more savings on to
the consumers. With this leaner cost structure along with making better use of the
assets in the company, Kraft can generate new savings which will allow for more
reinvestment into the company. This will help expand the company and create an ever
larger advantage over the competition. They also try to align with the trends of the
industry and channels within the industry.
Another major strategy for the industry is to expand globally. There are many countries
around the world growing at rapid rates. Being able to develop relationships within
these countries would help boost the companies tremendously. They could become
some of the world’s largest manufacturers and sellers of packaged foods and
beverages. The global market today allows for many opportunities to help expand any
company that can create an advantage in those markets.
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Another strategy that firms can use is integrity in the workplace. While this is closely
related to consumer and customer service, having a well-grounded company in the
community is a huge benefit. This starts with having a good core of employees. By
showing support to the employees, they will respond better to the challenges they face
everyday in the business world. They will respond better to consumer and customer
complaints and be more helpful to those people who have the complaints or questions.
Having a good environment to work in can never be underestimated either. A good
environment creates more efficiency and quality in the workplace and in the products
being produced. More efficiency in the workplace will lead to lower production costs and
higher profits.
Six different but equally important values are what a good company within our industry
should stand for. These values are innovation, quality, safety, respect, integrity, and
openness. Company wide participation is these values will help create and maintain any
advantage they can get. These values should be what the world expects of a firm and
what they expect of themselves. Most of these values should be incorporated into the
more specific strategies above, but these values can not be under-valued. They will
help any company create a competitive advantage in their industry. Looking at Kraft
specifically, their vision of helping people around the world eat and live better is a key
underlying value of all their strategies to gain different advantages in the industry.
Being able to differentiate yourself not only in quality of product, but also in the quality
of your company will lead any company to the front of their industry. This is what Kraft
strives to achieve. (www.kraft.com)
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Firm Competitive Advantage Analysis
The strategic choice a company makes is one of the most influential factors in
positioning themselves within an industry. Kraft Foods Inc. has three main competitive
core strategies: research and development, cost differentiation, and marketing.
Kraft’s strategy includes “helping people around the world eat and live better.” This
mainly shows the dedication Kraft has toward customer service and the health of those
customers. Expansions in property lines such as the Nabisco 100 calorie packs and
South Beach Diet Cereal Bars are just a beginning of the shift towards helping the
consumer eat healthier. Kraft is not in the business of making a low quality, generic
product. The company uses a lot of time and effort in their Research and Development
department to differentiate their products from the competition. Higher quality goods
and nutritional value are part of Kraft’s stance in the competitive industry pointing their
competitive advantage towards differentiation.
When a customer purchases a product from Kraft they are not only getting a fair priced
good, but also one of high quality backed by a strong brand image. Kraft has an image
that has 35 major brands that have lasted over a century. This directly affects Kraft’s
ability to maintain low costs in a highly competitive industry. As the largest brand food
and beverage company headquartered in the U.S. and the second largest worldwide,
Kraft has the ability and capital to give high quality products at low costs. With a Market
Capital of 58.4 billion dollars, Kraft is capable of marketing many of the world’s leading
food brands while keeping them affordable. Their Market Capital not only allows these
products to be sold in the United States but in five different sectors worldwide. This
again shows Kraft’s differentiation and competitive advantage against its competitors.
In December of 2000, Kraft acquired Nabisco, expanding their manpower and respected
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brand name. Nabisco helped expand Kraft’s product line and stabilize them as the
leading competitor in their industry.
In a world whose boundaries are getting smaller by the minute, a company in the food
and beverage industry must capitalize among the widely expanding market. Kraft’s
newly elected Chief Executive Officer Irene Rosenfeld has decided to increase
advertising spending which will directly correspond with the companies expected
growth. For example, discounts and coupons are advertised daily in newspapers and
magazines all over the world, not to mention that you can find popular children’s movie
and cartoon characters on the front of many of Kraft’s products to help increase
consumer demand. Kraft foods international beverage business accounted for more
than 40% of their revenues in 1999. Due to Kraft’s recent financial flexibility, they were
able to purchase select European assets from United Biscuits. This should give Kraft a
much-needed boost in global cookie sales. With this just being one example of the
many products Kraft is taking global; it is a window view of the global success that is to
come.
Being such a large, diverse company such as Kraft can result in some risks. These can
include large scale marketing issues and increasing distances among shipping. Also
costs can come into play, requiring higher product profit and consumer consumption.
However, with diverse problems and situations come solutions that make Kraft what
they are today. By producing high valued products and healthy alternatives, Kraft can
maintain their strong consumer brand loyalty. (Kraft Value Line; November 3, 2006)
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Accounting Analysis of Firm and Industry
Key Accounting Policies
Kraft Foods, Inc. follows an accounting policy or method that is generally accepted in
the United States (US GAAP). Some estimates are made to the financial statements
and are based off of historical experience and/or other assumptions they feel is
reasonable. The key success factors for Kraft Foods Inc. are keeping costs low,
marketing effectively, and research and development.
Keeping costs low across the board is a major concern for Kraft. Since Kraft products
are mainly products with many substitutes offered, keeping their cost of goods sold
down reduces the final price for the product. In reducing the final price, customers are
more willing to purchase a Kraft product rather than their competitor since the Kraft
brand image is so strong. According to Kraft’s income statements from 2001 to 2005,
cost of goods sold is becoming a larger part of net sales, stating that cost of goods sold
is increasing, while net sales is not.
Marketing for Kraft Foods Inc. is a key principle for this company. Marketing provides
their consumers with knowledge of their new products or reminders of their old.
Marketing costs for Kraft Foods, Inc. include advertising, consumer incentives and trade
promotions. Such programs include discounts, coupons, rebates, in-
store display incentives and volume based incentives. Advertising costs
are expensed as incurred. Consumer incentive and trade promotions
activities are recorded as a reduction of revenue based on amounts
estimated as being due to customers and consumers at the end of the period, based
primarily on historical utilization and redemption rates. (Kraft 2005 10K)
Research and development are key for Kraft to stay competitive. With the increasing
demand for low fat, low calorie products, Kraft must continually pump money into
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research and development to maintain a competitive advantage. Kraft’s research and
development disclosure is quite clear and detailed in their 10K statements.
In review, there are many key success factors for Kraft Foods, Inc. All must be checked
for impairment and watched for significant changes. Monitoring these key elements will
help outside investors see how successful Kraft Foods, Inc. truly is.
Accounting Flexibility
As mentioned in the key accounting policies section of this report, Kraft’s key success
factors are keeping cost low, marketing effectively, and research and development. To
achieve these goals, Kraft uses its basic knowledge of the firm’s activities to predict and
make estimates on the company’s financial position.
In a highly competitive market, such as Kraft’s, consumers are looking for the lowest
prices possible. From time to time the Company may need to reduce the prices of some
of its products to respond to competitive and customer pressures and to maintain
market share. Kraft does this by trying to avoid, and if necessary, respond to
commodity and other cost increases. Operation results will suffer if profit margins
decrease, so Kraft tries to remain consistent but flexible on cost allocation and cost of
goods sold values. With consolidation of some supermarkets, warehouse clubs, and
other food distributors, the buying power of these sophisticated customers is increasing.
This can reduce inventories and induce lower pricing placing extra costs on the books
for Kraft. To counter some of these costs, the Company tries to induce supply chain
efficiency, including efforts to align product shipments more closely with consumption
by shifting some of its customer marketing programs to a consumption based approach,
financial condition of customers and general economic conditions (Kraft 10K). Also, in
relation to financial statements, Kraft adjusts some long-lived asset impairment and
forecasts probabilities of inventory inflow and outflow through distributors, adjusting
inventory levels before losses are incurred. By adjusting production amounts
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accordingly to predictions, the Company can reduce cost of productions and cost of
goods sold.
Marketing costs are an important expense for a company in a competitive market. As
required by U.S. GAAP, marketing costs are expensed in the year in which the costs
relate. The company also expenses advertising costs as they are incurred. Amounts on
the year-end consolidated balance sheet, with respect to marketing costs, are not
deferred. Kraft takes a conservative standpoint in relation to recording marketing costs
by not delaying the recording of the expenses. Kraft believes that this outlook keeps
financial statements current and very dependable when making forecasts or doing
valuations to acquire future cost figures and avoid revenue overstatements.
When taking a first look at Kraft, one would think that Research and Development
would not be an influential area on the financial statements. The truth is that Kraft
spends an adequate amount of time and funds in this area. R&D expenses are
accounted for in the year incurred and can sometimes be distributed through the Altria
Group, Inc. This assists in distributing costs efficiently and increasing profitability
figures.
Kraft Foods, Inc. implements flexible plans that help keep it competitive among its
industry. The allocation of costs in the areas of marketing, research and development,
and production keeps Kraft’s financial statements current and valuable in firm analysis.
This is why the Company’s good financial flexibility helps it stay on top of accounting
struggles that disable others among the competition. (Kraft 2005 10K)
Accounting Strategy
After careful review of past financial statements, it is accurate to assume that Kraft’s
accounting strategy and policies are conservative and reflect the economic realty of the
company. Kraft’s policies are in accordance with generally accepted accounting
procedures as set forth by the Financial Accounting Standards Board. Although Kraft
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uses several different accounting methods of valuation within its multi-national
company, everyone is a choice offered by the GAAP.
Kraft’s accounting policies are very similar to some of its competitors, for example,
General Mills and Sara Lee. Some of the methods that they share include revenue
recognition and retail inventory. Revenue is recognized upon shipment or delivery of
goods when title and risk of loss are passed to the customers. For Kraft, shipping and
handling costs are classified as part of cost of sales. When dealing with inventory, Kraft
along with its competitors use the LIFO accounting method for a majority of its
domestic inventories. For Kraft, the cost of other inventories is determined using the
average cost method. The industry uses the straight line method for depreciation of
property, plant, and equipment. However, the useful lives used for depreciation will
vary from asset to asset and company to company.
Though the companies are similar, Kraft has made some recent changes in the Stock
Options department. In 2005 stockholders approved the Kraft 2005 Incentive Plan. With
this plan, Kraft may grant to eligible employees awards of stock options, stock
appreciation rights, restricted stock, and other awards based on Kraft’s Class A common
stock. A maximum of 150 million shares of Kraft Class A common stock may be issued
under this new plan. Kraft applies the intrinsic value-based method in accounting for
the various stock plans. Compensation expense is what is recognized for the restricted
stock awards. In 2004, the FASB issued SFAS No. 123 a.k.a. “Share-Based Payment”.
(Kraft 2005 10K). It requires companies to measure compensation cost for share-based
payments at fair value. Kraft adopted this new standard on January 1, 2006; fortunately
it will not have a material impact on its consolidated financial position, results of
operations or cash flows.
With regards to Kraft’s key success factors, the “2005 plan” directly relates to having
employees who show integrity and efficiency in the workplace. This plan encourages
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employees to do just that. With more efficiency in the workplace the lower production
costs will be and will result in higher profits.
Qualitative and Quantitative Analysis
Qualitative and quantitative factors were used when determining the quality of Kraft’s
quality disclosures. The tables below are the sales and core expense manipulation
diagnostics tables. They contain three ratios each for the past five years (2001-2005).
Kraft (sales) 2001 2002 2003 2004 2005
Net Sales / Cash from Sales 0.9966
0.9995
1.0084
1.0054
0.9954
Net Sales / Accounts Receivable 9.3370
9.5388
9.0525
9.0844
10.0777
Net Sales / Inventory 9.6609
8.7886
9.1229
9.3322
10.2043
Kraft’s net sales to cash from sales ratio has hovered around 1 for the past five years
with a slight rise in 2003-2004, but then declining again in 2005. This could be a
potential red flag; however, it is best to compare it with the industry to see if it is just
within Kraft, or an industry change. There also may be concern with the net sales to
accounts receivable ratio. It was increasing from 2001-2002, but then began to
decrease, and then increased again in 2005. The increase in 2005 could be caused by
a decrease in accounts receivables for that year. The net sales to inventory ratio has
continued to increase with just a slight decrease in 2002. Again, it is necessary to look
at the industry analysis before raising concern.
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The following tables are the sales manipulation diagnostics for two competitors, Sara
Lee and ConAgra Foods.
Sara Lee (sales) 2001 2002 2003 2004 2005
Net Sales / Cash from Sales
0.9866
1.0169
0.9975
1.0032
1.0101
Net Sales / Accounts Receivable
10.8140
9.6275
10.0101
10.3458
9.4382
Net Sales / Inventory
6.4415
7.0259
6.7451
7.0084
7.1470
ConAgra Foods (sales) 2001 2002 2003 2004 2005
Net Sales / Cash from Sales
1.0147
0.9855
0.9720
1.0370
0.9992
Net Sales / Accounts Receivable
15.6101
17.4988
20.6438
10.8064
11.274
Net Sales / Inventory
4.9415
5.4783
6.7330
5.5958
5.5716
Comparing Kraft with Sara Lee and ConAgra Foods will help to determine whether or
not there is an industry change or a potential red flag within Kraft. In the net sales to
cash from sales ratio, both the industry and Kraft has hovered around one. They have
all increased and decreased a little bit throughout the years proving that this is mostly
due to a change within the industry. Kraft seems to be moving in an opposite direction
with the net sales to accounts receivable ratio. This could be a potential red flag for
Kraft. Kraft’s net sales to inventory ratio seems to be increasing and decreasing along
the same lines as the industry confirming that it is a change with in the industry. All of
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these ratios are fairly consistent with the industry verifying that Kraft is most likely not
manipulating their sales numbers.
Net Sales / Cash from Sales
0.920.94
0.960.98
11.02
1.041.06
2001 2002 2003 2004 2005
KraftSara LeeConAgraIndustry Average
Net Sales / Accounts Receivables
0
5
10
15
20
25
2001 2002 2003 2004 2005
Kraft
Sara Lee
ConAgra
Industry Average
Net Sales / Inventory
0
2
4
6
8
10
12
2001 2002 2003 2004 2005
Kraft
Sara Lee
ConAgra
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It is also important to compare the core expense diagnostics. Below is Kraft’s core
expense manipulation diagnostics:
Kraft Foods Inc. 2001 2002 2003 2004 2005
Sales / Assets 0.52 0.52 0.51 0.54 0.59
Changes in CFFO / OI 0.02
0.06
0.07
(0.02)
(0.11)
Changes in CFFO / NOA 0.01
0.06
0.05
(0.01)
(0.07)
Some factors stand out in these ratios. First the negative results in the last two ratios,
as well as some inconsistency in the last two ratios. In the sales to assets ratio, the
numbers are fairly consistent with a slight increase in 2005. This could either be to an
increase in sales or a decrease in assets. In 2004 and 2005, the changes in cash flow
from operations were negative. This caused the negative ratios in changes in cash flow
from operations to operating income and net operating assets.
In order to determine if Kraft’s ratios were in line with its competitors, it is best to
compare them with the competitors in their industry. Below are the core expense ratios
for Sara Lee and ConAgra Foods.
Sara Lee 2001 2002 2003 2004 2005
Sales / Assets
1.64
1.28
1.15
1.29
1.34
Changes in CFFO / OI
(0.02)
0.20
0.06
(0.01)
0.18
Changes in CFFO / NOA
(0.02)
0.11
0.03
(0.01)
0.06
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ConAgra Foods Inc. 2001 2002 2003 2004 2005
Sales / Assets
1.52
1.44
1.10
0.99
1.14
Changes in CFFO / OI
(0.50)
1.77
(1.26)
(0.08)
0.46
Changes in CFFO / NOA
(0.30)
1.42
(0.95)
(0.05)
0.35
When comparing the industry’s sales to asset ratio to Kraft, they all seem to be fairly
consistent with a slight increase in 2005. However, Kraft’s sale to asset ratio is a lot
smaller than the industry. This is because Kraft’s assets are nearly double of what their
sales are each year. The changes in cash flow from operations to operating income and
net operating assets ratios seem to be steady in year 2004. For each company they are
all negative ratios, which could be a result of an industry change. However, all the
ratios for each company seem a little bit irregular from each other making it a difficult
to make any conclusions about the industry average.
Sales / Assets
0
0.5
1
1.5
2
2001 2002 2003 2004 2005
KraftSara LeeConAgraIndustry Average
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Changes in CFFO / OI
-1.5-1
-0.50
0.51
1.52
2001 2002 2003 2004 2005
KraftSara LeeConAgraIndustry Average
Changes in CFFO / NOA
-1.5-1
-0.50
0.51
1.52
2001 2002 2003 2004 2005
Kraft
Sara Lee
ConAgra
Quality of Disclosure
Kraft Foods Inc. is very thorough in their business section of the 10-K. They break
down segments of their company such as, beverages, cheese, convenient meals,
snacks, and cereals, in North America and Internationally. This gives even greater
detailed information about the condition of their company in each of these segments.
They also disclose information about threats of competitors within the American and
International market. They explain how they plan to increase their advertising to
improve their brand image, which helps gain a competitive advantage over other
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companies. Kraft also discusses their three-year restructuring program. This program
is designed to improve its cost structure and consumption of assets.
Kraft’s footnotes of their financial information are specific in explaining the way that
they report their employee benefit and postretirement plans, goodwill, and income
taxes. They also disclose how they handle their foreign exchange rates. Kraft uses
forward foreign exchange contracts to alleviate any changes in exchange rates.
Overall Kraft reports a good quality of disclosures on their 10-K statements.
Potential “Red Flags”
In order to evaluate Kraft’s accounting procedures, it is important to look for potential
“red flags” that might catch an analyst’s eye within the firm. As discussed earlier in the
previous qualitative and quantitative factors, Kraft has certain issues that might be
looked into further as far as accounting policy goes. However, this is no cause for
alarm. Kraft has been involved in certain changes within the organization that have led
them to slight ups and downs in regard to their financials. The company justifies these
changes by thoroughly disclosing all the potential “red flag” information within the
Management’s Discussion and Analysis of Financial Condition section of the 10-K. For
example, Kraft’s internal restructurings have affected the net impact of lower asset
impairment, exit and implementation costs on earnings, and diluted earnings per share
from continuing operations. Kraft consistently explains the affect of these
circumstances within their financials and the value to which they were incurred. This in
return eliminates any further suspect within the firm in regard to US GAAP. In
comparison to the industry, Kraft continues to fade away from potential suspicion due
to their high market share, consistent revenues, and their superior brand loyalty. (Kraft
2005 10K)
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As stated before, Kraft has chosen to go with a more conservative approach to their
accounting methods. All of which comply with the U.S. GAAP regulations and
procedures. Kraft uses the LIFO method for their domestic inventory. This means that
they have a lower net income and therefore pay fewer taxes on that income. As stated
in the Accounting Strategy section, Kraft recognizes its revenue upon shipment or
delivery of goods. This strategy helps lower the risk and cost of lost goods to the
company; because, they recognize the revenue only after that risk is transferred to the
customer. Kraft has also been very informative about their new retirement and
incentive plan. With Kraft’s high level of disclosure about their accounting methods and
everything that goes into their 10-K reports, there is little room to be able to accuse
Kraft of falsifying their financial reports.
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Financial Statement Ratio Based Analysis
The purpose of this section is to review the financial ratios for Kraft in the past five
years, as well as forecast the following ten years of financial statements. Using these
ratios it is possible to analyze Kraft’s past and present performance in order to look for
any possible trends in the company. There are several different methods for
performance of measures that are used in the ratio analysis which include liquidity,
operating efficiency, profitability, and capital structure. From these ratios we will be
able to determine the company’s overall standing in the food produce industry and
evaluate its progress over time.
In the following sections, the basic 14 ratios will be used when assessing Kraft’s
performance in the areas of liquidity, operating efficiency, profitability, and capital
structure. Also, the forecast of the next ten years will help us to determine in what
direction the company is headed and what can be done to continue these positive
trends and/or remove the negative ones. This analysis is vital to Kraft because it
provides its investors with public information that gives them the ability to compare
with other competitors in its industry.
Ratio Analysis
Financial statement analysis helps to evaluate management performance and trends
within the company. Kraft’s analysis was broken down into four major areas: liquidity,
operating efficiency, profitability, and capital structure.
Liquidity ratios explain how liquid the company actually is. They try to measure the
firm’s ability to pay back their current liabilities. In Kraft the current ratio was
increasing until 2005, when there was a negative change. This was due to the
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decrease in current assets in 2005. There was essentially no change in the quick asset
ratio in the past two years.
Operating efficiency measures how efficient the firm is in terms of their operations
management. Kraft’s accounts receivable ratio increased in year 2005. This increase
reduced the number of days’ sales outstanding, which helped Kraft become more
efficient because there was less accounts receivable tied up. Inventory turnover acted
in the same way as the receivables turnover. Working capital turnover seems to be the
most unstable. The changes in working capital are mostly because of the changes in
current assets and current liabilities.
The profitability analysis measures how profitable a firm is in terms of sales and net
income. For Kraft, the gross profit margin and net profit margin decreased in 2004 due
to an increase in sales. The operating expense ratio began to decrease in 2002. This
was probably also caused by an increase in sales each year. Asset turnover remains
stable, with a slight increase in 2005. Return on assets and return on equity also began
to decrease in 2004 because of a decrease in net income from the previous years.
Capital structure analysis is the last area examined in financial statement analysis. This
refers to the companies sources of financing. The debt to equity ratio has been
decreasing each year. This is a good thing because this indicates that debt has become
a smaller proportion of the total financing. Times interest earned has greatly increased
since 2001. This ratio shows the sufficiency of income from operations to cover
required interest charges. The debt service margin measures how much of cash that is
provided by operation that will cover the annual payments on long-term liabilities.
There was a big increase in 2002, but then has been decreasing since then. (Kraft
2005 10K)
- 29 -
CROSS-SECTIONAL ANALYSIS
Liquidity Ratios
Current Ratio
This ratio is very important in analyzing a company’s liquidity. Kraft shows that they are
constantly around a ratio of one. Compared to the industry, Kraft usually has the lowest
ratio. This means that they usually have just enough current assets to cover their
current liabilities. Their competitors and the industry show more liquidity with higher
current ratios.
Current Ratio
0
0.5
1
1.5
2
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
Quick Asset Ratio
Looking at the graph, we can see that the industry as a whole as increased from year to
year since 2001. Kraft increased with the industry until 2003. Then they decreased a
bit, and leveled off in 2005. In terms of liquidity, Kraft doesn’t vary too much, but
recently has been the lowest in the industry.
Quick Asset Ratio
00.20.40.60.8
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
- 30 -
Inventory Turnover
From this graph, we can see that the all the firms in the industry stay fairly close to
each other. Kraft definitely shows the highest of the firms, and has increased in recent
years. This means that Kraft would have a lower days supply of inventory than the rest
of their competitors and the industry. In 2005, their days supply of inventory is 55.9.
This means that they have enough in inventory to cover almost 56 days of supplies to
the consumers.
Inventory Turnover
0
2
4
6
8
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
Accounts Receivable Turnover
This graph shows that Kraft and Sara Lee’s turnover ratio are the lowest. This means
that they do not have a lot of cash from sales. Most of their sales are put on account.
ConAgra Foods is by far the highest, and they move in the same directions as the
industry. The lower turnover ratios for Kraft and Sara Lee will result in higher days sales
outstanding. Kraft’s days sales outstanding are 36.21 for 2005. This means that Kraft
has credit sales outstanding for about 36 days.
Accounts Receivable Turnover
05
10152025
2001 2002 2003 2004 2005Years
Valu
es
Kraft
Sara Lee
ConAgraFoodsIndustry Avg.
- 31 -
Working Capital Turnover
From this graph, one can see that the firms are sporadic in their respective turnovers.
This is mostly contributed to the varying current ratios. Kraft usually moves against the
other firms in the industry. In recent years, Kraft has dropped below their competitors.
This shows again that Kraft’s liquidity is lower than that of their competitors and the
industry.
Working CapitalTurnover
-100-50
050
100150200
2001 2002 2003 2004 2005
Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
Profitability Ratios
Gross Profit Margin
Kraft and Sara Lee show the highest margins, and they seem to move together. Kraft’s
high margin is a good sign, in that they receive more profit on each sale than some of
the other firms. This is good for profitability and operating efficiency.
Gross ProfitMargin
0.00%10.00%20.00%30.00%40.00%50.00%
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
- 32 -
Operating Expense Ratio
From this graph, one can see that firm’s ratios are spread out. Kraft is the lowest by far.
This shows that Kraft has found ways to cut down on their SG&A expenses. This leads
to more profit on each sale. One way that Kraft could have lowered their expenses is by
spreading their expenses out over more operations.
Operating ExpenseRatio
0.00%10.00%20.00%30.00%40.00%
2001
2002
2003
2004
2005
Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
Net Profit Margin
This graph shows that in the recent years, Kraft is definitely outperforming the industry.
This means that Kraft is able to retain more of its sales in net income than the rest of
the industry. This is a big key to a profitable firm that wants to grow.
Net Profit Margin
0.00%2.00%4.00%6.00%8.00%
10.00%12.00%14.00%
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
- 33 -
Asset Turnover
The competitors and industry average move together; while Kraft stays at the very
bottom of the industry. This can be attributed to Kraft not holding as many assets as
the other firms. This assumption can also be seen with the low current ratios stated
earlier.
Asset Turnover
0
0.5
1
1.5
2
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
Return on Assets
From this ratio, one can see that in the more recent years the industry moves together.
With the low asset turnover and current ratios, Kraft again is towards the bottom of the
industry.
Return on Assets
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2001 2002 2003 2004 2005Years
Valu
es
KraftSara LeeConAgra FoodsIndustry Avg.
- 34 -
Return on Equity
With the last profitability ratio, one can see Kraft and ConAgra Foods are very similar.
In more recent, years the industry has moved more towards them at the bottom. This
shows that Kraft’s investors do not get as much of a return on their investment as what
other investors get from the other companies in the industry.
Return on Equity
0.00%50.00%
100.00%150.00%200.00%250.00%
2001
2002
2003
2004
2005
Years
Valu
es
Kraft
Sara Lee
ConAgraFoodsIndustry Avg.
Capital Structure Ratios
Debt to Equity
From this graph, one can see that the companies started off in different areas, but have
all pretty much moved with the industry to lower levels. Kraft has decreased a little, but
definitely remains at the bottom. This means that Kraft has higher equity compared to
its liabilities than the rest of companies in the industry. Kraft certainly has the best
ratio.
Debt to Equity
02468
10
2001 2002 2003 2004 2005Years
Valu
es
Kraft
Sara Lee
ConAgraFoodsIndustry Avg.
- 35 -
Times Interest Earned
For the most part the industry moves together except for Kraft. In more recent years,
Kraft maintains the highest ratio in the industry. This shows that Kraft has the most
operating income to cover its interest expense.
Times InterestEarned
02468
10
2001 2002 2003 2004 2005Years
Valu
es
Kraft
Sara Lee
ConAgraFoodsIndustry Avg.
Debt Service Margin
Overall, Kraft definitely moves with the industry trends. Kraft started out with the
highest ratio, but has recently fallen to the middle of the industry. This means that Kraft
used to have plenty of income from operations to cover its current installments on long-
term debt, but more recently has had either its income go down or its current
installments on long-term debt go up.
Debt Service Margin
0
5
10
15
20
2001 2002 2003 2004 2005Years
Valu
es
Kraft
Sara Lee
ConAgraFoodsIndustry Avg.
- 36 -
Liquidity
Kraft seems to not be very liquid. We can see this most when we look at the current
and quick asset ratios. These mainly deal with the most liquid assets, and Kraft is
towards the bottom of the industry. They do have a bright spot in the inventory
turnover though. The increase and being the highest in the industry is very favorable
for their liquidity. When we look at the account receivable turnover, we go back to the
same story of Kraft not being very liquid. With the working capital turnover, we saw the
Kraft usually moved against the trends and was the highest in the industry for a while,
but in more recent years, Kraft has fallen to the bottom.
Profitability
Kraft’s profitability is a totally different story than its liquidity. Kraft shows strong gross
profit margins and net profit margins compared to the industry. Team that up with the
lowest operating expense ratio, Kraft looks to be a very profitable company. Kraft hits a
little bit of a snag with their asset turnover, return on assets, and return on equity.
Kraft performs at the bottom of the industry in all three of these ratios, but the industry
has moved down towards Kraft in the recent years. Overall, Kraft seems to be a fairly
profitable company within the industry.
Capital Structure
For the most part, Kraft’s capital structure seems pretty steady within the industry.
They have the lowest debt to equity ratio. This means that their debt is usually paid off
in a timely manner. Kraft’s times interest earned is definitely higher than the industry
which is not a great thing for the investors. Until recent years, Kraft has had a high
debt service margin compared to the industry. This would indicate that Kraft usually has
plenty of income from operations to cover current payments on their long-term debt.
That is a good key to any strong capital structure. (Sara Lee 2005 10K and ConAgra
2005 10K)
- 37 -
Forecast Financial Statements and Analysis Income Statement Analysis In order to forecast Kraft for the next 10 years, it is important to recognize the internal
growth rate and sustainable growth rate calculations. The equations used to calculate
Total Inventories 3026 3382 3343 3447 3343 3343 3344 3344 3344 3345 3345 3345 3346 3346 3346 Assume .01% growthDeferred income taxes 466 511 681 749 879Assets of discontinued operations held for sale 1458
Other current assets 221 232 217 245 230
Total current assets 7006 7456 8124 9722 8153 8561 8989 9438 9910 10406 10926 11472 12046 12648 13280 Assume 5% growth rateProperty, plant and equipment, at cost:
Land and land improvements 387 387 407 400 388Buildings and building equipment 2915 3153 3422 3545 3551Machinery and equipment 9264 10108 11293 11892 12008Construction in progress 706 802 683 646 651
Class A common stock, no par value (555,000,000shares issued in 2005 and 2004)Class B common stock, no par value (1,180,000,000shares issued and outstanding in 2005 and2004.00
Additional paid-in capital 23655 23655 23704 23762 23835Earnings reinvested in the business 2391 4814 7020 8304 9453Accumulated other comprehensive losses -2568 -2467 -1792 -1205 -1663(including currency translation of $(1,290)in 2005 and $(890) in 2004)
23478 26002 28932 30861 31625Less cost of repurchased stock (65,119,245 -170 -402 -950 -2032Class A shares in 2005 and 29,644,926 ClassA shares in 2004)
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 55798 57100 59285 59928 57628 31073 32626 34258 35970 37769 39657 41640 43722 45908 48204
Book Value Per Shares 13.53199 14.92317 16.56794 17.54311 17.72036
Shares Outstanding 1735 1731 1722 1705 1670
Current Market Value 34.03 38.93 32.22 35.61 28.17
- 53 -
Common Sized Balance Sheet (Millions) 2001 2002 2003 2004 2005
ASSETSCash and cash equivalents 0.29% 0.38% 0.87% 0.47% 0.55%Receivables (less allowances of $92 in 5.61% 5.46% 5.68% 5.91% 5.87%2005 and $118 in 2004)Inventories:
5.42% 5.92% 5.64% 5.75% 5.80%Deferred income taxes 0.84% 0.89% 1.15% 1.25% 1.53%Assets of discontinued operations held 2.43%for saleOther current assets 0.40% 0.41% 0.37% 0.41% 0.40%
Total current assets 12.56% 13.06% 13.70% 16.22% 14.15%Property, plant and equipment, at cost:
Land and land improvements 0.69% 0.68% 0.69% 0.67% 0.67%Buildings and building equipment 5.22% 5.52% 5.77% 5.92% 6.16%Machinery and equipment 16.60% 17.70% 19.05% 19.84% 20.84%Construction in progress 1.27% 1.40% 1.15% 1.08% 1.13%
Total current liabilities 15.91% 12.56% 13.26% 15.15% 15.14%Long-term debt 14.58% 18.24% 19.55% 16.22% 14.71%Deferred income taxes 9.02% 9.51% 9.88% 10.79% 10.53%Accrued postretirement health care costs 3.32% 3.31% 3.19% 3.15% 3.35%Notes payable to Altria Group, Inc. and afiliates 8.96% 4.48%Other liabilities 6.15% 6.67% 5.99% 4.77% 4.92%
Total liabilities 57.92% 54.76% 51.88% 50.09% 48.65%
Contingencies (Note 18)SHAREHOLDERS' EQUITY
Class A common stock, no par value (555,000,000shares issued in 2005 and 2004)Class B common stock, no par value (1,180,000,000shares issued and outstanding in 2005 and
2004.00Additional paid-in capital 42.39% 41.43% 39.98% 39.65% 41.36%Earnings reinvested in the business 4.29% 8.43% 11.84% 13.86% 16.40%Accumulated other comprehensive losses -4.60% -4.32% -3.02% -2.01% -2.89%(including currency translation of $(1,290)in 2005 and $(890) in 2004)
42.08% 45.54% 48.80% 51.50% 54.88%Less cost of repurchased stock (65,119,245 0.00% -0.30% -0.68% -1.59% -3.53%Class A shares in 2005 and 29,644,926 ClassA shares in 2004)
Total shareholders' equity 42.08% 45.24% 48.12% 49.91% 51.35%
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 100.00% 100.00% 100.00% 100.00% 100.00%
Net revenues 29,234 29,723 30,498 32,168 34,113 35,478 36,897 38,372 39,907 41,504 43,164 44,890 46,686 48,553 50,496 Assume a 4% growth rateCost of sales 17,566 17,720 18,531 20,281 21,845 21,948 22,826 23,739 24,689 25,677 26,704 27,772 28,883 30,038 31,239 Grew at Average of Gross Profit Margin
Gross profit 11,668 12,003 11,967 11,887 12,268 13,529 14,070 14,633 15,218 15,827 16,460 17,119 17,803 18,516 19,256Marketing, administration and research 5,748 5,709 6,123 6,658 7,135costsIntergration costs and a loss on a sale of a food plant 82 111Separtation programs 142Asset impairment and exit costs 6 603 479(Gains) losses on sales of businesses, 3netAmortization of intangibles 962 7 9 11 10
Net revenues 100.000% 100.000% 100.000% 100.000% 100.000%Cost of sales 60.088% 59.617% 60.761% 63.047% 64.037%
Gross profit 39.912% 40.383% 39.239% 36.953% 35.963%Marketing, administration and research 19.662% 19.207% 20.077% 20.698% 20.916%costsIntergration costs and a loss on a sale of a food plant 0.280% 0.373% 0.000% 0.000% 0.000%Separtation programs 0.000% 0.478% 0.000% 0.000% 0.000%Asset impairment and exit costs 0.000% 0.000% 0.020% 1.875% 1.404%(Gains) losses on sales of businesses, -0.027% -0.269% -0.102% 0.009% -0.317%net 3.291% 0.024% 0.000% 0.000% 0.000%Amortization of intangibles 3.291% 0.024% 0.030% 0.034% 0.029%
Operating income 16.707% 20.570% 19.214% 14.337% 13.930%Interest and other debt expense, net 4.916% 2.850% 2.180% 2.070% 1.864%
Earnings from continuing operations before 11.791% 17.720% 17.034% 12.267% 12.066%income taxes and minority interest
Provision for income taxes 5.353% 6.288% 5.941% 3.960% 3.544%
Earnings from continuing operations before 6.438% 11.432% 11.093% 8.306% 8.522%minority interest
Minority interest in earnings from continuing 0.000% 0.013% 0.013% 0.009% 0.009%operations, net
Earnings from continuing operations 0.000% 0.000% 11.079% 8.297% 8.513%(Loss) earnings from discontinued operations, 0.000% 0.000% 0.318% -0.012% -0.797%net of income taxes
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIESNet earnings 1,882 3,394 3,476 2,665 2,632Adjustments to reconcile net earningsto operating cash flows:
Depreciation and amortization 1,642 716 813 879 879Deferred income tax (benefit) provision 414 278 244 41(Gains) losses on sales of businesses, 3netIntegration costs, net of cash paid 82 111Seperating Programs 142Loss on sale of discontinued operations 32Impairment loss on discontinued operations 107Asset impairment and exit costs, net of 6 493 315cash paidCash effects of changes, net of the effectsfrom acquired anddivested companies:
Receivables, net 23 116 23 65InventoriesAccounts payableIncome taxesAmounts due to Altria Group, Inc. and affiliates 138Other working capital items 90
Change in pension assets and postretirementliabilities, netOther 143 234 228
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIESCapital expendituresPurchases of businesses, net of acquired cashProceeds from sales of businesses 1,668Other 52 35 38 69 28
Net cash provided by (used in) investing 525 Assume .1% growth rateactivities
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIESNet (repayment) issuance of short-term 2,505 819borrowingsLong-term debt proceeds 4,077 3,325 1,577 832 69Long-term debt repaidRepayment of notes payable to Altria Group,Inc. and affiliatesNet Proceeds from sale of Class A Common Stock 8,425Increase (decrease) in amounts due to Altria 142 660 107Group, Inc. and affiliatesRepurchase of Class A common stock (170)Dividends paidOther
Net cash used in financing activities
Effect of exchange rate changes on cash 1 15 34and cash equivalents
Cash and cash equivalents:Increase (decrease) 53 299 34Balance at beginning of year 162 215 282
Present Value of Future Dividends $0.87 $0.90 $0.92 $0.95 $0.98 $1.01 $1.03 $1.06 $1.09 $1.12
Total Present Value of Forecast Future Dividends $9.94Continuing (Terminal) Value (assume no growth) $31.62Present Value of Continuing (Terminal) Value $16.12
Estimated Value per Share 2005 $26.06Estimated Value per Share November 2006 $27.72Earnings Per Share $1.57 $1.58 $1.60 $1.61 $1.63 $1.65 $1.66 $1.68 $1.70 $1.71Dividends per share $0.94 $1.03 $1.13 $1.24 $1.37 $1.51 $1.66 $1.82 $2.00 $2.20Book Value Per Share $17.72
Actual Price per share $34.36Cost of Equity 6.97% gGrowth Rate 0 0 0.01 0.03 0.05 0.07 0.09
Cash Flow from Operations 3,498.64 3,603.60 3,711.71 3,823.06 3,937.75 4,055.88 4,177.56 4,302.89 4,431.97 4,564.93Cash Provided (Used) by Investing ActivitiesFree Cash Flow (to firm) 3,502.58Discount Rate (6.77% WACC) 0.937 0.877 0.822 0.770 0.721 0.675 0.632 0.592 0.555 0.520Present Value of Free Cash Flows 2286.85 2233.08 2180.39 2127.09 2074.97 2022.51 1971.28 1919.96 1869.89 1819.93Total Present Value of Annual Cash Flows 20,506Continuing (Terminal) Value (assume no growth) 51766.56Present Value of Continuing (Terminal) Value 26,898Value of the Firm (end of 2005) 47,404Book Value of Debt and Preferred Stock $114.9
PV Factor 0.935 0.874 0.817 0.764 0.714 0.667 0.624 0.583 0.545PV of AEG $0.00 $0.01 $0.02 $0.02
Total PV of AEGContinuing (Terminal) Value gPV of Terminal Value $0.71 -0.08 -0.06 -0.04 -0.02 0 0.02 0.04Total PV of AEG $0.69 0.02 $93.45 $95.89 $99.96 $108.09 $132.49 N/