Question:
I have heard that Kraft intends to split itself into two companies. Is this a good thing for Kraft shareholders? Will this stock be one to hold, buy, or sell? Why do companies do this, and if it is a good thing, what makes it a good thing?
Answer:
Companies generally spin off to unlock value. We own Kraft Foods, Inc. in one of our income portfolios. The company made the announcement in August 2011, but the deal will not go through until the end of 2012. The split is a good deal, because there are two segments of the company that have different growth profiles. One division is the snack business, which we believe will carry a higher price to earnings ratio, because it is a faster growth company. The other is the grocery business, which we believe will have higher sales margins but lower growth because groceries tend to grow slower but have higher efficiencies. We agree with other analysts that the grocery side will likely pay higher dividends, close to 5%.
We are holding the company right now and believe the spinoff will unlock value of the two companies. When companies spin off, there are transaction costs for the shareholder to consider, but with Kraft, we believe the benefit of the shares’ appreciation will outweigh the costs. In our portfolio, we have quality criteria, and once the spinoff is complete, we will consider the quality criteria. While one of the companies should meet our criteria, there is a chance the other one will as well.
The grocery division of the company is estimated to be a $17 billion company. However, the negative for the company is that they are not expected have the bargaining power that the snack division has. The snack division is expected to have $32 billion in sales.
Bottom line is Kraft is still a good buy and a good value. We continue to buy Kraft at its current price.
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