Sweet Tooth for Mondelez About to Decay

NEW YORK ( The Street) -- For most of 2013, food giant Mondelez ( MDLZ) has had to answer naysayers who have insisted that expectations for the company's margin growth were pure hype. But with the stock now trading at a 52-week high on year-to-date gains of 35%, management has done its part to silence the skeptics. Mondelez may look sweet now, but its stock performance may be about to spoil.

Despite its strong gains, Mondelez still sports a P/E that is higher than other food giants like Nestle ( NSRGY), ConAgra ( CAG) and Danone ( DANOY) This implies there are still high expectations heading into 2014. But I would caution new investors to be careful here.

While it's true that management has delivered where it matters, I'm just not convinced that revenue growth -- organic or otherwise -- can maintain its upward trend without adversely impacting profitability. And with the bar being set so high on a stock that's far from cheap, it may only take a slight dip in Mondelez's margins to trigger a pullback.

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Now I'm not suggesting that Mondelez, which has posted several quarters of above-average organic growth, is destined for failure. The company's recent gains seem to have fueled the Street's expectations of outperformance. But I think the "easy money" has already been made, and the time to develop a sweet tooth for this stock has passed.

Why? Consider that since Mondelez split off from Kraft's (KRFT) $35 billion snack food business in 2012, management has worked hard to expand the company's geographic footprint. I've always believed this to be brilliant strategy, given the global success that Kraft had generated from iconic brands like Oreo, Nabisco and Trident.

However, in the most recent quarter, Mondelez began to experience some weakness in international markets.  They achieved only a 2% year-over-year revenue increase, missing Street estimates by 1%. The revenue struggle was partly blamed on double-digit revenue declines in China, where Mondelez generates roughly $1.1 billion in annual revenue.

The decline occurred even though management increased its capital spending in that region, seeking growth. In fairness, this has been a profitable bet: Mondelez has doubled its Chinese revenue over the past couple of years. On the flip side, the disappointing results affirm my belief that the Street's growth expectations are overinflated.

The good news, though, is that Mondelez was able to offset its China weakness with an 11% growth in emerging markets -- areas that include Brazil, Russia and India. This led to a 2.5% earnings beat, which also increased 14% year over year.

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Now I'm not going to disparage this performance. A 14% profit increase is no small task in a highly competitive industry. But it's not the best I've ever seen, either, although that's how the stock is being priced. And let's not forget that the company is only one year removed from operating as a business segment of Kraft Foods. There's still sort of a start-up mentality at play here.

I believe the Street is betting too much that Mondelez can quickly improve upon its productivity to grow its margins. As it stands, the company still trails more mature peers like General Mills (GIS) and Hershey (HSY). In that light, it's a little puzzling that the stock is so highly valued.

For these valuations to make sense, Mondelez will require significant infrastructure builds in emerging markets, as well as upgrades in the company's production lines in established regions like the U.S. Only then will Mondelez produce the sort of margin improvement that's worth the risk. Even then it will take at least two years for that value to be realized.

Management might prove me completely wrong. They have done an exceptional job of overcoming obstacles, after all. But the current valuation presumes flawless execution against strong competition. In an industry that has given investors nothing but indigestion over the past couple of years, Mondelez's stock seems poised to turn sour.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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