Kraft Shares — 3 Pros, 3 Cons

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In January 2010, Berkshire Hathaway’s (NYSE: BRKB ) Warren Buffett went on CNBC and gave his opinion on one of his largest holdings, Kraft (NYSE: KFT ).  As expected, he did not mince words, saying that the company’s massive acquisition of Cadbury was “dumb.”  He even said he felt poorer. Perhaps Buffett was being too grumpy.  Since his comments, the shares of Kraft are up a tidy 17%, and that doesn’t include the stock’s hefty dividend (it is currently at 3.3%) But going forward, will Buffett turn out to be right?  Or does Kraft still have room to grow? Here’s a look at the pros and cons: Pros Global giant.   In the consumer world, Kraft is a power player. It’s the world’s No. 2 food company, with revenue of nearly $50 billion and earnings of $3.6 billion.  The company’s products are sold in roughly 170 countries and there are operations in more than 75 countries.  In all, 11 brands produce more than $1 billion in revenue.  Examples include Trident gum, Oreo, Oscar Mayer meats, Kraft cheeses and Maxwell House coffees. Fiscal discipline.   Kraft has a top-notch management team, with a clear focus on cost management.  This actually gets easier as the company scales its operations and realizes economies.  But Kraft isn’t too fanatical — it understands that it must still provide enough resources for marketing and product development to remain competitive. Emerging markets.   Clearly, this is the big market opportunity for Kraft.  Already, about 28% of total revenue comes from emerging markets.  And Kraft is certainly going to continue its investments.  For example, the company recently launched the Oreo in India.  So far, it has been a big success.  This actually is the case in other emerging markets.  The Oreo business is expected to be worth $700 million in the emerging markets for 2011, which compares to only $175 million in 2006. Cons Maturation.   To move the needle, Kraft needs to produce blockbusters.  The problem is that this is extremely difficult to do in markets like North America and Europe.  Thus, Kraft will likely not be a top-line story.  After all, there are not many huge consumer goods companies left to buy. The Cadbury deal.   So far, it looks like this has been a con.  Pulling off a cross-border merger is always difficult, especially with a firm that has a long history.  Kraft appears to be having problems with the integration and has lost some key executives.  Costs.   Kraft is a large buyer of commodities like cocoa, wheat, corn, soybeans and sugar.  Of course, there has been a surge in many of these raw materials.  While Kraft has been able to pass along higher prices, there are limits to this strategy. Another issue is that Kraft’s distributors — supermarket chains, supercenters and club stores — are exerting more power.  This puts more pressure on margins.    Verdict Despite his misgivings, Buffett still owns 6% of Kraft’s shares and is the largest holder.  It's a world-class company that is in the same league of his other top holdings, like Coca-Cola (NYSE: KO ), Procter & Gamble (NYSE: PG ) and American Express (NYSE: AXP ) However, Kraft is no longer a bargain, trading at 20 times earnings. If anything, there are continuing pressures on costs — as well as difficulties in finding top-line growth.  At the same time, the global economy is looking a bit shaky.  Thus, a slowing of discretionary spending will further mute Kraft’s momentum. Even though the company has a great platform, the cons still outweigh the pros.  For investors, it makes sense to hold off on the shares for now. Tom Taulli's latest book is " All About Short Selling " and he has an upcoming book called " All About Commodities ."  You can find him at Twitter account @ttaulli .  He does not own a position in any of the stocks named here.