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Kraft Foods Group Inc (KRFT): A Solid Quarter Indeed

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Earlier this month Kraft Foods Group Inc (NASDAQ:KRFT), a packaged food and beverage company recently spun off from the old Kraft, reported its first quarter earnings. Kraft Foods focuses mainly on the United States, meaning that growth is expected to be fairly slow since the US market is mature. Kraft reported that revenue grew by 2.1% year-over-year to $4.55 billion, beating analyst estimates by about 1.5%. Adjusted EPS was $0.76, down from last year but soundly beating analyst estimates by $0.12 per share.

Cost savings

Kraft Foods Group Inc (NASDAQ:KRFT)’s CEO Tony Vernon had this to say about the quarter:

Our first-quarter results reflect strong returns on our new product innovations to date, as well as the fact that our cost savings outpaced our plans to reinvest in our brands. In the months to come, we’ll execute our marketing playbook more broadly across our portfolio and we expect to see good progress in both top- and bottom-line performance for the full year.

The gross margin for the quarter increased slightly to 33.06% from 32.54% a year ago, while the SG&A expenses dropped by 5.7%. Combined, this caused the operating income to rise 9.2%, or 11.8% excluding asset impairment and other special items.

The reason why net income fell year-over-year is a large increase in interest expense. The company assumed about $10 billion worth of debt as well as $4.4 billion in pension obligations from the spin-off, so while interest payments were next to nothing in the first quarter of 2012 they rose to $123 million in the first quarter of this year.

Because of this added interest net income is not a very useful number to compare to a year ago. Looking at operating income makes more sense, and that number rose significantly.

Outlook

The company provided guidance for 2013, which includes organic revenue growth in line with the growth of the North American food and beverage market. The company also expects full year EPS to be about $2.75, flat compared to 2012. For the sake of comparison the total interest payments in 2013 will be about $0.82 per share based on this quarter’s payments. Assuming that the tax rate for the full year will be 33.5%, operating income per share should be $4.96 based on the EPS estimate given. This is up from $4.48 in 2012, an increase of 10.7%. Again, because of the added interest payments this is the number that really matters.

Bad publicity

Kraft Foods Group Inc (NASDAQ:KRFT)One of Kraft Foods Group Inc (NASDAQ:KRFT)’s popular products is Capri Sun, a kids’ drink that comes in a pouch-like container. The product contains no preservatives, which is a likely reason for some of its popularity, but apparently this has lead a fungus-related issue. Researchers at Indiana State University have found that fungus can grow in Capri Sun pouches, especially when the pouch is punctured or damaged. The type of fungi which grows, however, is generally not harmful to people.

This story doesn’t seem to be all that widespread, although the researchers are planning to submit the work for publication. Kraft Foods Group Inc (NASDAQ:KRFT) has acknowledged that mold can grow in punctured pouches and urges consumers to throw out damaged containers. This is the kind of story, though, which could cause consumers to abandon the drink due to the inherent “gross-ness” of the problem. Although in the first quarter Capri Sun volume was strong, the company could see reduced sales in the future. The silver lining is that consumers may be drawn to Kool-Aid as an alternative, which is also owned by Kraft Foods Group Inc (NASDAQ:KRFT).

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