• by Karlene Lukovitz , February 16, 2010

Kraft Foods expects to realize annual pre-tax cost savings of at least $675 million by the end of 2012, some of which will be used to further increase advertising and consumer spending as a percentage of revenue, chairman/CEO Irene Rosenfeld reported during the company's Q4/year-end fiscal 2009 earnings call on Tuesday.

 

The global food giant increased advertising and consumer spending to 7.2% of net revenues in 2009, versus 6.7% in 2008, she pointed out. The increased advertising support for key brands, including the Philadelphia Cream Cheese "Spread a Little Love" and Miracle Whip "We Will Not Tone It Down" television campaigns, have been "extremely well received" and effective at building the brands' franchises, Rosenfeld said.

In addition, significant investments in improving the quality/taste of Kraft's products since 2007 have enabled "improved alignment of price levels," as consumers now prefer about two-thirds of Kraft's products over the competition, versus the 44% that were preferred in 2006, she said.

Kraft is projecting one-time implementation cash costs of approximately $1.3 billion through the end of 2012 associated with its $18.5 billion acquisition of chocolate maker Cadbury plc. Kraft expects to own 100% of Cadbury within six to eight weeks, according to EVP/CFO Timothy McLevish.

Kraft raised $9.5 billion for the acquisition earlier this month through a U.S. corporate bond sale/debt offering, and will also apply approximately $2.5 billion from its sale of its North American frozen pizza business to Nestlé (expected to close by mid-year 2010) toward the acquisition.

Kraft expects the annual $675 million in savings by 2012 for the combined company to include $300 million resulting from operational synergies, $250 million from lower general and administrative costs, and $125 million from marketing and selling synergies/efficiencies of scale, Rosenfeld reported.

The acquisition will make Kraft the world's largest confectioner and the leader in sweet snacks. The "fast-growing" confections and snacks segments will now represent the majority of Kraft's portfolio (30% and 21%, respectively), with six of its 11 brands with annual revenues exceeding $1 billion falling into those categories, Rosenfeld said.

Complementary sales/distribution channels represent significant opportunities for higher margins and growth in the confections/snacks segments, and Kraft is "confident that the brands will thrive with focused incremental marketing and merchandising investments," she added.

The acquisition will also provide Kraft with leading positions in emerging markets, including combined net revenues of $1.5 billion in Brazil and $1 billion in Russia, as well as a "meaningful entry" into India, according to Rosenfeld.

For Q4 2009, Kraft reported a 3.2% increase in net revenues, to $11 billion, and organic net revenue growth (excluding the favorable impact of currency) of 0.4%. Gains in volume/mix were partially offset by lower price levels and discontinuation of less profitable product lines.

Net revenue gains of 11.2% in developing markets and 8% in Europe offset a 1.5% decline in North America. Within N.A., most segments showed declines in net revenues, including a decline of 13.7% in U.S. cheese. However, N.A. food service operations and U.S. convenient meals had gains of 8.2% and 3.9%, respectively, and U.S. grocery was up by a slight 0.1%.

For full-year 2009, net revenues declined 3.7% to $40.4 billion (primarily due to currency), while organic net revenues grew 1.5%. Operating income margin grew 450 basis points to 13.7%; diluted earnings per share grew 7%, to $2.03; and free cash flow grew 35%, to $3.8 billion.

Kraft said that the near-term targets for its base business continue to be organic net revenue growth of 4% or more and EPS growth at the high end of its 7% to 9% long-term growth objective. The company also affirmed its intention to restore operating income margins to "industry benchmarks in the mid-teens" by 2011.

The expected benefits of the Cadbury acquisition have raised the overall long-term organic revenue growth target to 5%, from 4%. That includes projected growth of 10%+ in developing markets (versus the previous 8% to 10% projection), 2% to 3% growth in Europe (versus previous growth of 1% to 3%); and 3% to 5% growth in North America (no change).

Long-term EPS growth for the combined company is targeted at 9% to 11%.

While Q4 net income gains exceeded analysts' expectations, some analysts expressed some skepticism about EPS growth expectations, given that while Kraft is projecting a five-cent gain on EPS as a result of the Cadbury acquisition, it also expects a five-cent reduction in diluted EPS on an annual basis resulting from its sale of the frozen pizza business, a strong performer in recent years.

The ultimate outcome of the Cadbury acquisition "is all about execution," Timothy Ramey of D.A. Davidson told CNBC News. While confections are a fast-growth business, Kraft's execution even on small deals has "been relatively poor," he said, noting that Davison downgraded its rating for the company to neutral on the news of the acquisition.