Kraft Foods Inc.: Market Analysis and Financial Performance

Overview of Kraft Foods

Kraft Foods is the world's second-largest food company, with revenues in 2009 of $40.4 billion. The company has nine brands each worth over $1 billion: Kraft, Oscar Mayer, Philadelphia, Maxwell House, Jacobs, Nabisco, Oreo, Milka, and LU. Approximately fifty brands in the company's portfolio generate revenues in excess of $100 million. Kraft operates with a geographic organizational structure based around three units — North America, Europe, and Developing Markets. The first two units are managed by product, and the latter by country (Kraft Foods 2009 Form 10-K).

Market Conditions

Kraft Foods operates in the mass-market grocery business. This industry can be characterized as a state of monopolistic competition. Competition is broad-based, products are differentiated — typically through branding but sometimes along product attribute lines as well — and consumers easily perceive these non-price differences. No single producer has sole control over price, and there are few barriers to entry or exit.

In general, there is ample supply and demand across Kraft's businesses. Supplies of factor inputs are governed by both world commodity markets and large supply companies. Kraft has some pricing power on account of its size, but because suppliers are often equally large entities, that power is only moderate. Because Kraft markets to a broad global audience, demand for its products is generally high. Demand may fluctuate with prevailing economic conditions, particularly in the Developing Markets segment; however, fluctuations are not severe because many of Kraft's products are staple foods.

The degree of differentiation in Kraft's markets introduces some price elasticity of demand. Kraft products are staples, but they are often priced at the higher end of the middle range. For many products, generic or low-cost alternatives exist. If Kraft prices too high, the perceived utility of its products decreases, driving demand toward lower-cost options. There are also cross-price elasticities of demand: if generic products — often perceived to be of inferior quality — become too expensive, consumers may simply purchase Kraft instead. As a food company, Kraft also competes indirectly with restaurants, and these cross-price elasticities are particularly notable for products where the difference between the restaurant version and the supermarket version is relatively small, such as pizza or coffee.

Government regulations in Kraft's business are typically related to food safety. In the United States, the Food and Drug Administration (FDA) governs food safety, primarily at the manufacturing level and in labeling. Similar agencies and programs exist in many other countries, particularly in the West. While the federal government administers the FDA, the cost of compliance falls on the food company itself — the higher the regulatory burden, the higher the resulting costs. Governments also regulate general business activities, with the degree of interference varying by country: generally lower in Western markets and higher in Developing Markets. Even in low-interference regions, merger and acquisition activity typically comes under regulatory scrutiny, as evidenced by recent UK government involvement in Kraft's takeover of Cadbury (Parliament.uk, 2010).

Competition in Kraft's businesses is typically intense. Kraft markets staple products in mainstream segments, and for any given product it faces numerous direct competitors at different price points as well as a large number of substitutes. Competition is based on both price and differentiation. Some of Kraft's competitors are equally large multinational enterprises, but the competitive landscape extends to very small businesses depending on the product and geographic market.

The market for Kraft products is expected to continue growing. North American and European markets are mature, so growth in those regions will be relatively slow. There is, however, considerable room for growth in Developing Markets, and this growth is correlated with broader economic development in those regions given Kraft's premium positioning. This dynamic is evident in the volatility of earnings in emerging markets (Form 10-K).

Financial Ratios

Kraft has a fairly solid balance sheet. The company's current ratio is 1.1, which is slightly below the industry average, while its quick ratio of 0.8 mirrors the industry average. The debt-to-equity ratio is 0.73, indicating a lower degree of leverage than the industry average. Kraft's slightly premium market position is reflected in its margins: the gross margin is 36.2%, above the industry average, while the net margin of 7.5% is in line with the industry average. Over the past five years, Kraft's margins have trended toward the industry average.

The maturity of Kraft's major markets, combined with intense competition, has meant that its returns have historically lagged the food industry average. Return on equity is 12.5%, versus an industry average of 22%. Return on assets is 4.7% and return on capital is 5.6%, both well below the industry average. Kraft is also less operationally efficient than its peers: receivables turnover (8.2), inventory turnover (6.7), and asset turnover (0.6) all fall below the industry average.

Overall, while Kraft is a relatively strong company, it underperforms its peers. The company has been largely unable to improve its performance on key metrics over the past ten years, with the notable exception of interest coverage. In most other measures, Kraft has shown little to no improvement in recent years.