KFT Preview: Handling the Private-Label Challenge

It is indicative of this bear market that even Kraft (KFT - commentary - Cramer's Take), a consumer staples stock with big problems, is beginning to look cheap now at $27. Using consensus EPS estimates of $1.91 and $2.02 for this year and next, respectively, the stock discounts 1% EPS growth in perpetuity.

The bear story in this environment is that a pressed consumer will turn increasingly to private label. IRI numbers for the four-week period ending in October show private-label gains for 85% of its tracked categories vs. 51% in the year-ago period and 53% on average since the start of 2006. Looking at the situation in food and at Kraft another way, over the past four weeks, branded players have lagged their categories' sales growth by 170 basis points, and Kraft has lagged its categories by 585 basis points. (Note: I realize that four-week periods can be distorted, but all of the last year's four-week periods show the same scary trend.)

Unit growth share comparisons, if I had them, would be even worse. Overall market share loss for Kraft would be near 2%. Given that it is still early in the recession to assess the consumer's longer-term situation and what an increased savings rate will do for consumption patterns, I would think that the lowest EPS estimates on the Street for Kraft, $1.84 and $1.70 for this year and next, respectively, cannot be ruled out and may even be high.

Using lower numbers, the stock discounts a 3% five-year growth rate and a 2% terminal growth rate after 10 years. I believe that this is probably a very cheap valuation, but I am not particularly certain that the $1.70 estimate for 2009 could not be flattish into 2010. Much like loan losses on mortgages, I believe that nobody really knows how high private-label penetrations and their attendant negative margin pressure can go in this recession, especially for poorly positioned food companies. There are lots of other better positioned consumer packaged goods stocks that are also very cheap at this juncture.

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At the time of publication, Thomas had no positions in the stocks mentioned.