Description

I believe that Mondelez offers an attractive investment opportunity at its current price.  The shares are reasonable on an absolute basis, and trading at a cheap multiple, versus its post-KRFT-spin history and the market.  In addition to an attractive valuation, fundamentals appear to be firming and there is the ever-present 3G/Berkshire option.  I place high odds that MDLZ can outperform the S&P 500 over the next five years.  

JGalt pitched MDLZ in 2015, their write-up is more thorough on background and the 3G angle.  I recommend checking it out as well.

Business Description:

            Mondelez (MDLZ) is a global manufacturer and marketer of cookies, crackers, salted snacks, chocolate, gum, candy, beverages, cheese, and grocery products.  Major brands include: Oreo, Chips Ahoy!, Ritz, TUC/Club Social, belVita, Cadbury Dairy Milk, Milka, Lacta, Trident, Hall’s and Tang.   The company generates more than 38% (YTD) of its sales from developing markets and more than 70% come from power brands (which are those listed in the prior sentence).

            Mondelez is a product of multiple acquisitions and spin-offs.  After acquiring Cadbury in 2010, in 2012 the company spun off its North American grocery business.  After the grocery spin-off, the remaining assets changed their name to Mondelez.  Mondelez retained the U.S. and Canadian snacks and confectionary business, excluding Planters and Corn Nuts, and all the business conducted outside of the US and Canada.  The spun-off entity retained the U.S. and Canadian grocery, beverages, cheese, convenient meals, Planters and Corn Nuts and export privileges for these brands (outside of Philadelphia cream cheese and certain powdered beverages).  

Reasonable Valuation:

            MDLZ is currently trading at 18.6x NTM forward earnings- I believe it's cheaper than this and lay out my rationale below.  But even at face value- the company is trading at a discount to the S&P 500 which I think is unwarranted- particularly in the context of where we are in the market cycle.

            MDLZ has about $175 million in intangible amortization running through the P&L, which was primarily generated from the Cadbury acquisition in 2010.  On an after-tax basis this amounts to about $0.10 per share.  Excluding this item the P/E would drop to 17.5x.

            Additionally, the company sold its coffee assets to a JAB controlled entity- JDE (Jacobs Douwe Egberts).   According to a March 2017 Moody’s report (https://www.moodys.com/research/Moodys-upgrades-JDEs-CFR-to-Ba2-stable-outlook--PR_364455) JDE has been de-levering faster than expected and generated over $1.1 billion in EBIT in 2016.

I expect equity income to be around $325 million in 2017, of which, approximately $210 million should be attributable to JDE- approximately $0.15 per share.  In 2016 JAB bought Keurig and this event puts a marker on the fair value of MDLZ’s interest.  MDLZ reduced its interest in JDE by 17% and rolled that $2 billion dollars into Keurig.   This valuation implies MDLZ’s remaining JDE stake is worth $3.1 billion, while its investment in Keurig is worth around $2 billion (only $1.6 billion of which is equity, $400 million is a loan).   This implies $3.25 to $3.50 in value per MDLZ share- which adjusting the P and E – will get the remaining Mondelez business to a 17.1x multiple.  I think a premium multiple is warranted for this business, 20x would seem reasonable.

Where Fundamentals Have Been:

            After peaking at $35.3 billion in sales in 2013 the company is set to post $25.7 billion this year.  This decline is driven by the creation of a joint venture for its coffee business in 2015 (which generated between $3.6 and $4.0 billion in sales annually) and foreign exchange impacts which reduced top line by $5.4 billion from 2013.  In addition to these two headwinds, MDLZ has also been pruning underperforming business lines- for instance, in 2017 the company sold its Australian cheese and grocery portfolio and its French confectionery businesses, which generated $500 million in annual sales.

            On the margin front, the company has been doing well, cost cutting and expense discipline have more than offset other margin headwinds the company has faced.  This dynamic can be seen in the following chart:

(Source: Company Reports)

The company anticipates posting operating margins in the 17-18% range in 2018 (street is at 17.3%).

Where Fundamentals Might Be Heading:

            In 2017 the company is likely to post organic sales growth below 1%.  The main pain points this year have been seen in the North America business (particularly biscuits), while other markets around the world have done Ok (though certainly they are slower than a few years prior).

            In regard to emerging markets- this business posted 1.6% organic growth in the first half of 2017, and posted 4.8% in Q3 (though this comparison was slightly flattered by the Malware issue in June). Irene Rosenfeld from the Q3 2017 call: “we’re seeing sequential acceleration in emerging market category growth, consistent with our view that these markets are generally improving”.

            Foreign exchange is likely to be another area of help moving forward.  The dollar index began its surge in mid-2014, the index peaked last fall, from which point it has pulled back 10% or so.  Foreign exchange has been a headache for Mondelez, translation impacts alone have reduced operating income by $630 million since 2014 through 2016 year-end.  Through the first nine months of this year, the effect has continued to be negative- but ultimately, this should move to a tailwind.

            In the U.S. MDLZ utilizes direct-store-delivery system (DSD) for cookies (Nabisco).  DSD is common with products such as milk, eggs, and bread.  Its essentially a system that allows the manufacturer to deliver directly to the end retailer.  In early 2017, Kellogg, the maker of Keebler, announced that they would discontinue their DSD strategy (starting in Q2).  Direct store delivery allows the retailer to dedicate less labor and assets (in the form of warehousing) to provide customers product.  K moving from this model is expected to be a benefit to MDLZ, management is expecting to see positive market share impact in Q4 and throughout 2018.  Importantly, if gains don’t materialize, MDLZ could change its mind and abandon DSD.  Credit Suisse believes that moving to a warehouse model would save $500 million.

            Lastly, in June the company was subject to the malware attack that crippled many corporations.  Some of the missed sales were regained, but it is estimated that completely lost sales amounted to $100 million.  This should provide a 40 bps tailwind to organic growth figures next year.

3G Option:

            JGalt’s write-up in August 2015 provides good commentary on the potential for KHC to acquire MDLZ.  I don’t have anything meaningful to add to this discussion.  I have read press reports (as I am sure you have as well) suggesting 3G has up $15 billion in dry powder to deploy.  There has also been talk suggesting they might start a new platform outside of KHC enterprise focused on non-food assets.  A NY Post report suggested Buffet/3G group might be cooling to the idea of doing another big acquisition right now.  Lastly, in a recent CNBC interview, Buffett firmly voiced opposition to a MDLZ deal.

I think the case can still be made that there is fat to cut at MDLZ:

(Source : Cap IQ)

I think the investment in MDLZ works without the take-out thesis, I view this a free/cheap option.

New CEO:

            On August 2nd of this year, MDLZ announced that long-time CEO and Chairman Irene Rosenfeld would step down effective November 20th of this year.  She will remain Chairman of the board until March 2018.  In her spot, Dirk Van de Put from McCain Foods would be named CEO and then Chairman.

            To overview Irene Rosenfeld, she became CEO of Kraft in June 2006 when the stock was trading at $30.90.  From the time she became CEO through today an investor would have realized a 78% return, versus the S&P 500 of 168%.   XLP, without dividends reinvested, returned 135%.  I think its safe to chalk up Irene’s tenure as a failure.

            Van de Put has been the CEO of McCain for 6 years and was the COO for one year before that.  He has previously worked at Danone, Novartis, Mars, and Coke.  There is not much information about Dirk or McCain (which primarily is focused on potatoes, and has a big foodservice business).  From the MDLZ press release: “During his six-year tenure as CEO, he grew net sales by more than 50 percent, generating more than 75 percent of that growth organically, with EBITDA growing double digits each of the last six years.”  From the Consumer Goods Forum: “In the years prior to managing the Americas Division, Dirk was at the helm of the Latin America Division of Danone, which grew in seven years from US$500 million to more than US$2.5 billion, posting an average annual growth above 20 per cent.”

            Dirk will receive a $38 million make whole award for forfeited multi-year performance incentives at McCain that he was slated to receive for above target business performance.  This award will be $10 million in cash, $18 million in deferred stock units that time vest, and $10 million in PSU.  The PSU is subject to a one year performance period of 1/1/2018 through 12/31/2018 and is dependent on organic sales and EPS growth.  After the performance period the award is subject to time/service vesting through 2020.  I find this very odd, typically equity performance awards are based on multi-year performance at MDLZ.  Essentially Dirk gets 7x salary if he hits sales and EPS goals in 2018.

Catalyst

• New CEO is a possible change agent, other than that, no immediate catalyst.
• MDLZ could be subject to a large one-time tax bill- they have $19.8 billion in indefinitely reinvested accumulated foreign earnings. I would view any weakness caused by this issue to be a buying opportunity.