Kraft’s second quarter results benefit from greater exposure to international markets

Kraft’s recently released second quarter 2010 financial results show strong growth in both volume and net revenues, with the company’s performance driven by new assets (ie Cadbury) in all geographies. Net revenues grew by 25.3% to US$12.3 billion, including the impact of 22.8 percentage points from the Cadbury acquisition.

However, in organic terms, which excludes the impact of acquisitions and disposals and exchange rate fluctuation, Kraft’s net revenues increased by only 2.2%. The company also cut down its full-year organic growth forecast from at least 4% to between 3-4% in anticipation of a still challenging economic environment and the ongoing costs associated with Cadbury’s integration.

Cadbury boosts performance in developing markets

During the long takeover battle for Cadbury, Kraft cited greater access to expanding international markets as one of the main benefits of the acquisition. On the basis of the first full quarterly results for joint operations, Cadbury boosted net revenues across all regions but most significantly in Kraft’s Developing Markets reporting segment, where net revenues increased by 73.4%, including a 61.4 percentage point impact from Cadbury.

Although organic net revenues for Developing Markets within Kraft’s base business grew 10.4%, exceeding Cadbury’s base business growth of 4%, Cadbury’s existing operational infrastructure in emerging regions also provided an expanded platform to distribute the enlarged portfolio.

The weakest performing emerging regions for Kraft were Central and Eastern Europe and the Middle East and Africa, which grew by mid-single digits. Meanwhile, organic net revenues in both Latin America and Asia-Pacific achieved double-digit growth rates.

This is not wholly surprising given that the Eastern European packaged food market was severely affected by the recent global economic crisis. 2009 saw regional retail value sales contract by nearly 14%. Moreover, over the 2010-2015 period sales are still not expected to bounce back strongly, with Eastern Europe forecast to be the slowest growing emerging region with a constant value CAGR of 1.7%.

Regardless of what happens in Eastern Europe, the acquisition and integration of Cadbury’s operations means that Kraft has greatly strengthened its position to benefit from the strong growth coming from packaged food markets in Asia-Pacific and Latin America, both of which are expected to increase at a 3% CAGR over the 2010-2015 period and jointly account for 60% of the global absolute retail value gain for the packaged food market over the same period.

Based on 2009 market data, the joint Kraft/Cadbury entity became the second largest packaged food conglomerate in Latin America, a significant improvement on Kraft’s number eight position before the acquisition. Meanwhile, in Asia-Pacific, the company now joins the ranks of the top 10 packaged food companies across the region, moving from 17th to ninth position in 2009.

Continued decline in domestic North American market

Although Cadbury’s net revenues continued to grow in the US, achieving gains of 7.5% for the base business, despite a still challenging economic environment, this was not sufficient to lift the joint entity out of a 1.3% decline across the North American region.

Kraft has argued the weak performance is down to a still weak consumer environment, reduced merchandising by a key customer in the US and intensified competition core categories, such as cheese and biscuits. Meanwhile, Cadbury’s performance was boosted by new product launches, such as Trident Layers, Stride Shift and Dentyne Pure gum.

Kraft’s US volume sales have suffered in particular as input costs (such as wheat, cocoa, soybean oil, and corn) remain above long-term averages, which could continue to weigh on Kraft’s profitability.

In order to offset a portion of these costs, Kraft would need to charge higher prices, but as consumer spending power remains weak it is likely that Kraft’s volume could come under further pressure. Kraft has announced it timed many of its new product launches, as well as a higher advertising spend, in the US for the second half of the year, which could drive a better performance over the last two quarters of the year.

Outlook for 2010 financial year

For the full 2010 financial year, Kraft has confirmed its guidance of operating earnings per share of at least US$2.00 but has adjusted its forecast net revenue growth from 4% to a range of 3-4%.

The greater exposure to emerging markets via the integration of Cadbury and some new product launches have ensured a good second quarter performance for the company, but the group will continue to face considerable challenges, not least continued reduced spending power in developed markets and fluctuating raw material prices across the industry.