Kraft Foods Inc. Equity Valuation and Analysis
Valued at November 1, 2006
Lauren Groenteman: Lauren.Groenteman@ttu.edu
Rachel Watkins: Rachel.C.Watkins@ttu.edu
Jeremy Anthony: Jeremy.A.Anthony@ttu.edu
Andrew Little: Andrew.M.Little@ttu.edu
Nate Claxton: Nate.Claxton@ttu.edu
Neel Huey: Neel.E.Huey@ttu.edu
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Kraft Foods Inc. Valuation
Table of Contents
Executive Summary
3
Business Strategy Analysis
6
Industry Overview
8
Firm Competitive Advantage Analysis
13
Accounting Analysis of Firm and Industry
15
Financial Statement Ratio Based Analysis
27
Cross Sectional Analysis
29
Forecasted Financial Statement Analysis
37
Equity Valuation
40
Intrinsic Valuation
41
Valuation Conclusion
47
Appendix
48
Appendix A
49
Appendix B
52
Appendix C
58
Appendix D
61
Appendix E
68
Resources
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69
Executive Summary
Investment Recommendation: Overvalued, Sell
11/1/2006
KFT- NYSE
52 Week Ranges
Revenue (2005)
Market Capitalization
$34.36
$27.44-$36.67
$34,113 Mil.
$57.614.5 Mil.
EPS Forecast
FYE 1/31 2005(A) 2006(A) 2007(E) 2008(E)
EPS
$1.55
$1.57
$1.58
$1.60
Shares Outstanding
1,670,000,000
Ratio Comparison
Trailing P/E
Forward P/E
Forward PEG
M/B
Dividend Yield
3-Month Avg Daily Trading Volume
Percent Institutional Ownership
2.87%
2,799,040
84%
Book Value Per Share (mrq)
ROE
ROA
Est. 5 Year EPS Growth Rate
Cost of Capital Est.
20-Year
5-Year
1-Year
1-Month
Published
R2
.093
.092
.092
.085
$17.72
8.89%
4.57%
1%
Beta
.531
.528
.529
.511
.65
Altman Z-Score (2005)
.0655
.0677
Moderate Risk
Valuations Estimates
Actual Current Price
Intrinsic Valuations
Discounted Dividends
Free Cash Flows
Residual Income
Abnormal Earning Growth
Long-Run Residual Income Perpetuity
6.97%
KD
WACC
Industry
21.09
20.85
0.1475
3.07
Ratio Based Valuations
P/E Trailing
P/E Forward
PEG Forward
Dividend Yield
M/B
Ke
.0697
.0696
.0696
.0689
Ke Estimated
Kraft
15.01
39.20
19.86
1.59
2.123
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Chart Source: Big Charts
$34.36
15.01
39.20
19.86
2.8%
1.59
$27.72
$30.07
$25.55
$32.34
$26.52
Executive Summary
Kraft is the world’s second largest food and beverage company in the world. Kraft has
established their place in the market based on their marketing, high research and
development, and low costs. Their name and brand image are key staples within the
industry. Although the dominant company in the industry, Kraft have two main
competitors; Sara Lee and ConAgra Foods. Their threat of new entrants is low due to
the various barriers to entry since the major diversified foods industry is highly
competitive. (www.kraft.com)
Kraft’s accounting policies are very conservative. Their accounting disclosure is very
transparent. Due to these factors of their disclosure we can reasonably assume that
their accounting policies are reliable and trustworthy. In Kraft’s annual reports, they
also reveal any negative information and discuss how they plan to correct their
problems. These practices show the lack of a need to manipulate their annual reports.
This lack of a need is due to Kraft’s solid framework.
By computing the core financial ratios, we were able to get a better view of Kraft within
the industry. While looking at the liquidity ratios specifically, we could see that even
with Kraft having the highest inventory turnover, they were still one of the most illiquid
companies in the industry. On the other hand, Kraft seems to be a very profitable
company. They show strong gross profit margins and net profit margins compared to
the industry. Kraft’s capital structure seems to be fairly steady within the industry.
They have the lowest debt to equity ratio, which shows that they pay off their debt
within a timely manner. However, their times interest earned was the largest, which is
bad for the investors.
By forecasting out Kraft’s annual reports, as well as their ratios, we were able to gain a
better understanding of what Kraft’s position will be like in ten years. We found that
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Kraft will grow at a steady rate within the next ten years. Due to the importance of
these projected numbers, we tried to forecast as accurately as possible.
After analyzing our valuations of Kraft, we found that they are overvalued in each of the
five valuation models. Kraft’s actual price per share is $34.36. The first four valuation
models, dividend discount model, discounted free cash flows, residual income, and
long-run residual income perpetuity all showed estimated values ranging from $25-$28.
The abnormal earnings growth model calculated to be $32.34, showing the closest
estimate to the actual market price. Based on these valuations, we found Kraft to be
overvalued and strongly recommend selling.
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Business Strategy Analysis
Strategy analysis for Kraft Foods Inc. consists of an analytical view of the company’s
business and industry structure. Key strategic factors emphasized include the five
forces model, competitive advantage tactics, and corporate strategy. We started by
examining the business and industry Kraft Foods Inc. competes in, along with their use
of the five forces model. We also classified the industry Kraft Foods Inc. is in, identified
their key success factors, and determined their competitive strategy analysis. The final
portion of this section discloses the corporate structure of Kraft Foods Inc. in reference
to value creation and imperfections at the corporate level.
Business Summary
Kraft Foods Inc. is the largest U.S. branded food and beverage company, and the
second largest in the world. It is grouped with the major diversified foods industry
since it covers so many market segments for food. Kraft Foods covers five major
segments including snacks, beverages, cheese and dairy, grocery, and convenience
meals. Kraft’s brands include more than 50, with the largest two being Kraft and
Nabisco. Kraft is the world leading brand of cheese, as well as the company’s best
known brand for salad and spoonable dressings, packaged dinners, barbecue sauce and
other products. Nabisco is the umbrella brand for the world’s leading cookies and
cracker business. Some of Kraft’s other brands include Oscar Meyer, the leading U.S.
processed meats brand; Maxwell House, a leading coffee brand; Philadelphia, the
world’s largest cream cheese; and Post, the third largest brand of ready-to-eat cereals
in the U.S. Kraft was started in 1903 by J.L. Kraft and is now headquartered in
Northfield, Illinois. (Kraft S&P 500 Report 10/3/2006)
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Kraft products can be purchased in over 150 countries around the
world. Its major market segments are the United States, Western
Europe, Latin America, and Canada. Kraft has currently 207
facilities world wide. (Kraft 2005 10K)
Over the last five years, Kraft’s annual sales volume growth has been .5%, while Kraft’s
main competitors Sara Lee and ConAgra Foods Inc. have had annual sales volume
growth of 1% and -13% respectively. The industry average is a -12% over the last five
years, proving that Kraft is a strong member in terms of sales growth in the diversified
major foods industry.
From 2001-2005, Kraft’s earnings growth has been 9% on an annualized basis, while
Sara Lee and ConAgra Foods Inc. has been .5% and -2% respectively. The industry
average is -1.5% and again Kraft proves a leader in the diversified foods industry.
(Kraft Value Line; November 3, 2006)
Kraft has a market capitalization of $58.4 billion dollars, making it a large cap company.
Kraft’s total assets over the last five years average around $58 million dollars. Over the
last five years, Kraft’s stock price has fluctuated to around $40 and has dropped to as
low as around $27. As of November 1, 2006 the price was $34.36.
(www.yahoo.finance.com)
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Industry Overview and Analysis
Five Forces
Competitive Force 1: Rivalry Among Existing Firms
Rivalry among existing firms already in the industry is the main influence of the average
level of profitability. Some industries compete aggressively on price, while others
compete on non-price elements, such as brand image.
Competitors
Moderate
Threat of New Entrants
Low
Substitute Products
Relatively High
Customer Power
High
Supplier Power
Low
In the major food industry, Kraft Foods is the world’s second largest food and beverage
company. Their brand portfolio is very well known with more than 50 brands including:
Maxwell House, Milka, Oscar Mayer, Philadelphia, and Post. Since Kraft is one of the
strongest packaged foods company, there is only moderate competition between the
main competitors. Kraft realizes that they cannot fully compete on price within the
industry, but on other elements like brand image and loyalty. (www.kraft.com)
Kraft has worked hard to diversify their products from other firms in the industry, such
as focusing on value added products and starting to capitalize on the national trend of
healthy eating. By diversifying their products, Kraft reduces their switching costs in the
industry.
By customers continuously buying Kraft products, brand loyalty has affected the
company in a positive way. Kraft is making better use of their assets to generate
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savings to reinvest in brand building which ultimately increases switching costs for
consumers.
Competitive Force 2: Threat of New Entrants
New Entrants may want to enter into an industry to earn greater profits. However, the
ease with new firms entering into the industry is a key element of profitability.
New entrants into the major food industry face a hard time competing within this large
economy of scale. Kraft alone competes in seven different business segments: North
America Beverages, North America Cheese and Foodservice, North America Convenient
Meals, North America Grocery, North America Snacks and Cereals, European Union, and
Developing Markets, Oceania and North Asia.
Since Kraft was one of the first major food industries they set the standard and
developed the first mover advantages. For example their brand loyalty has increased
the switching costs which make it difficult for other companies to compete in this
industry. New Entrants have a very difficult time contending with the existing
relationships that have already developed within the industry.
Competitive Force 3: Threat of Substitute Products
The food industry has a fairly high threat of substitute products. These threats exist
because of the price gaps between store bought products and privately labeled
products. For example, Kraft macaroni and cheese may sometimes struggle with Great
Value macaroni and cheese because of a price difference. If consumers believe these
products are similar, then they often substitute one for the other depending on the
cheaper price. However, customers that are not concerned with the price of the item
will choose Kraft because of the higher quality taste of a premium product.
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In the food industry, companies often compete with its substitute products during a
recession within the economy. For example, during these slow times, consumers tend
to purchase store brand salad dressing instead of Kraft in order to save money. During
slow revenue generated periods, Kraft can increase their advertising spending and their
efforts to narrow adverse price gaps. Even though substitute threats exist, Kraft is still
one of the largest food manufacturers and will continue to grow.
Competitive Force 4: Bargaining Power Buyers
There are two factors that affect the powers of buyers: price sensitivity and relative
bargaining power. Major food industry buyers are more price sensitive because their
products are undifferentiated. For example the packaging for Kraft salad dressing
containers represent a large portion of the buyer’s costs. If these packaging costs
increase, then Kraft may shop for lower cost alternatives.
Relative bargaining power is another aspect to determine the bargaining power of
buyers. Consumers have a higher bargaining power than major food industries because
they can decide whether or not to buy their products. In return, the industry has the
lower bargaining power because consumers cause a greater threat to the companies by
not doing business with them.
Competitive Force 5: Bargaining Power of Suppliers
Bargaining power of suppliers directly relates to the bargaining power of buyers. Thus,
suppliers have very little bargaining power. Due to the large amount of substitutes
available to their customers it makes it difficult for suppliers to compete and gain
power.
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Value Chain Analysis
Having and maintaining a competitive advantage in an industry is vitally important to a
company’s success. To achieve competitive advantage the company must have
strategies that allow them to create value for the firm. There are several factors and
strategies that allow the company’s within the industry a competitive advantage. The
most important for all companies including Kraft is the relationship with their
consumers. All the firms within our industry take great pride in trying to build superior
customer brand value. They achieve the advantage by giving more product benefits to
the consumers. With the high level of competition, every firm competes on prices.
Quality of food and packaging is also very important in creating an advantage. Kraft is
extremely good in all these areas. This is reflected by them being one of the leaders in
the industry. Kraft’s wide variety of helpful services along with the strong brand image
keeps consumers satisfied and willing to buy Kraft products time and time again.
The relationship with trade partners is also very important. Having the same trade
partner for years can become quite an asset to a company. It can help drive down
costs and raise profits. This will also allow companies to pass even more savings on to
the consumers. With this leaner cost structure along with making better use of the
assets in the company, Kraft can generate new savings which will allow for more
reinvestment into the company. This will help expand the company and create an ever
larger advantage over the competition. They also try to align with the trends of the
industry and channels within the industry.
Another major strategy for the industry is to expand globally. There are many countries
around the world growing at rapid rates. Being able to develop relationships within
these countries would help boost the companies tremendously. They could become
some of the world’s largest manufacturers and sellers of packaged foods and
beverages. The global market today allows for many opportunities to help expand any
company that can create an advantage in those markets.
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Another strategy that firms can use is integrity in the workplace. While this is closely
related to consumer and customer service, having a well-grounded company in the
community is a huge benefit. This starts with having a good core of employees. By
showing support to the employees, they will respond better to the challenges they face
everyday in the business world. They will respond better to consumer and customer
complaints and be more helpful to those people who have the complaints or questions.
Having a good environment to work in can never be underestimated either. A good
environment creates more efficiency and quality in the workplace and in the products
being produced. More efficiency in the workplace will lead to lower production costs and
higher profits.
Six different but equally important values are what a good company within our industry
should stand for. These values are innovation, quality, safety, respect, integrity, and
openness. Company wide participation is these values will help create and maintain any
advantage they can get. These values should be what the world expects of a firm and
what they expect of themselves. Most of these values should be incorporated into the
more specific strategies above, but these values can not be under-valued. They will
help any company create a competitive advantage in their industry. Looking at Kraft
specifically, their vision of helping people around the world eat and live better is a key
underlying value of all their strategies to gain different advantages in the industry.
Being able to differentiate yourself not only in quality of product, but also in the quality
of your company will lead any company to the front of their industry. This is what Kraft
strives to achieve. (www.kraft.com)
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Firm Competitive Advantage Analysis
The strategic choice a company makes is one of the most influential factors in
positioning themselves within an industry. Kraft Foods Inc. has three main competitive
core strategies: research and development, cost differentiation, and marketing.
Kraft’s strategy includes “helping people around the world eat and live better.” This
mainly shows the dedication Kraft has toward customer service and the health of those
customers. Expansions in property lines such as the Nabisco 100 calorie packs and
South Beach Diet Cereal Bars are just a beginning of the shift towards helping the
consumer eat healthier. Kraft is not in the business of making a low quality, generic
product. The company uses a lot of time and effort in their Research and Development
department to differentiate their products from the competition. Higher quality goods
and nutritional value are part of Kraft’s stance in the competitive industry pointing their
competitive advantage towards differentiation.
When a customer purchases a product from Kraft they are not only getting a fair priced
good, but also one of high quality backed by a strong brand image. Kraft has an image
that has 35 major brands that have lasted over a century. This directly affects Kraft’s
ability to maintain low costs in a highly competitive industry. As the largest brand food
and beverage company headquartered in the U.S. and the second largest worldwide,
Kraft has the ability and capital to give high quality products at low costs. With a Market
Capital of 58.4 billion dollars, Kraft is capable of marketing many of the world’s leading
food brands while keeping them affordable. Their Market Capital not only allows these
products to be sold in the United States but in five different sectors worldwide. This
again shows Kraft’s differentiation and competitive advantage against its competitors.
In December of 2000, Kraft acquired Nabisco, expanding their manpower and respected
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brand name. Nabisco helped expand Kraft’s product line and stabilize them as the
leading competitor in their industry.
In a world whose boundaries are getting smaller by the minute, a company in the food
and beverage industry must capitalize among the widely expanding market. Kraft’s
newly elected Chief Executive Officer Irene Rosenfeld has decided to increase
advertising spending which will directly correspond with the companies expected
growth. For example, discounts and coupons are advertised daily in newspapers and
magazines all over the world, not to mention that you can find popular children’s movie
and cartoon characters on the front of many of Kraft’s products to help increase
consumer demand. Kraft foods international beverage business accounted for more
than 40% of their revenues in 1999. Due to Kraft’s recent financial flexibility, they were
able to purchase select European assets from United Biscuits. This should give Kraft a
much-needed boost in global cookie sales. With this just being one example of the
many products Kraft is taking global; it is a window view of the global success that is to
come.
Being such a large, diverse company such as Kraft can result in some risks. These can
include large scale marketing issues and increasing distances among shipping. Also
costs can come into play, requiring higher product profit and consumer consumption.
However, with diverse problems and situations come solutions that make Kraft what
they are today. By producing high valued products and healthy alternatives, Kraft can
maintain their strong consumer brand loyalty. (Kraft Value Line; November 3, 2006)
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Accounting Analysis of Firm and Industry
Key Accounting Policies
Kraft Foods, Inc. follows an accounting policy or method that is generally accepted in
the United States (US GAAP). Some estimates are made to the financial statements
and are based off of historical experience and/or other assumptions they feel is
reasonable. The key success factors for Kraft Foods Inc. are keeping costs low,
marketing effectively, and research and development.
Keeping costs low across the board is a major concern for Kraft. Since Kraft products
are mainly products with many substitutes offered, keeping their cost of goods sold
down reduces the final price for the product. In reducing the final price, customers are
more willing to purchase a Kraft product rather than their competitor since the Kraft
brand image is so strong. According to Kraft’s income statements from 2001 to 2005,
cost of goods sold is becoming a larger part of net sales, stating that cost of goods sold
is increasing, while net sales is not.
Marketing for Kraft Foods Inc. is a key principle for this company. Marketing provides
their consumers with knowledge of their new products or reminders of their old.
Marketing costs for Kraft Foods, Inc. include advertising, consumer incentives and trade
promotions. Such programs include discounts, coupons, rebates, instore display incentives and volume based incentives. Advertising costs
are expensed as incurred. Consumer incentive and trade promotions
activities are recorded as a reduction of revenue based on amounts
estimated as being due to customers and consumers at the end of the period, based
primarily on historical utilization and redemption rates. (Kraft 2005 10K)
Research and development are key for Kraft to stay competitive. With the increasing
demand for low fat, low calorie products, Kraft must continually pump money into
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research and development to maintain a competitive advantage. Kraft’s research and
development disclosure is quite clear and detailed in their 10K statements.
In review, there are many key success factors for Kraft Foods, Inc. All must be checked
for impairment and watched for significant changes. Monitoring these key elements will
help outside investors see how successful Kraft Foods, Inc. truly is.
Accounting Flexibility
As mentioned in the key accounting policies section of this report, Kraft’s key success
factors are keeping cost low, marketing effectively, and research and development. To
achieve these goals, Kraft uses its basic knowledge of the firm’s activities to predict and
make estimates on the company’s financial position.
In a highly competitive market, such as Kraft’s, consumers are looking for the lowest
prices possible. From time to time the Company may need to reduce the prices of some
of its products to respond to competitive and customer pressures and to maintain
market share. Kraft does this by trying to avoid, and if necessary, respond to
commodity and other cost increases. Operation results will suffer if profit margins
decrease, so Kraft tries to remain consistent but flexible on cost allocation and cost of
goods sold values. With consolidation of some supermarkets, warehouse clubs, and
other food distributors, the buying power of these sophisticated customers is increasing.
This can reduce inventories and induce lower pricing placing extra costs on the books
for Kraft. To counter some of these costs, the Company tries to induce supply chain
efficiency, including efforts to align product shipments more closely with consumption
by shifting some of its customer marketing programs to a consumption based approach,
financial condition of customers and general economic conditions (Kraft 10K). Also, in
relation to financial statements, Kraft adjusts some long-lived asset impairment and
forecasts probabilities of inventory inflow and outflow through distributors, adjusting
inventory levels before losses are incurred. By adjusting production amounts
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accordingly to predictions, the Company can reduce cost of productions and cost of
goods sold.
Marketing costs are an important expense for a company in a competitive market. As
required by U.S. GAAP, marketing costs are expensed in the year in which the costs
relate. The company also expenses advertising costs as they are incurred. Amounts on
the year-end consolidated balance sheet, with respect to marketing costs, are not
deferred. Kraft takes a conservative standpoint in relation to recording marketing costs
by not delaying the recording of the expenses. Kraft believes that this outlook keeps
financial statements current and very dependable when making forecasts or doing
valuations to acquire future cost figures and avoid revenue overstatements.
When taking a first look at Kraft, one would think that Research and Development
would not be an influential area on the financial statements. The truth is that Kraft
spends an adequate amount of time and funds in this area. R&D expenses are
accounted for in the year incurred and can sometimes be distributed through the Altria
Group, Inc. This assists in distributing costs efficiently and increasing profitability
figures.
Kraft Foods, Inc. implements flexible plans that help keep it competitive among its
industry. The allocation of costs in the areas of marketing, research and development,
and production keeps Kraft’s financial statements current and valuable in firm analysis.
This is why the Company’s good financial flexibility helps it stay on top of accounting
struggles that disable others among the competition. (Kraft 2005 10K)
Accounting Strategy
After careful review of past financial statements, it is accurate to assume that Kraft’s
accounting strategy and policies are conservative and reflect the economic realty of the
company. Kraft’s policies are in accordance with generally accepted accounting
procedures as set forth by the Financial Accounting Standards Board. Although Kraft
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uses several different accounting methods of valuation within its multi-national
company, everyone is a choice offered by the GAAP.
Kraft’s accounting policies are very similar to some of its competitors, for example,
General Mills and Sara Lee. Some of the methods that they share include revenue
recognition and retail inventory. Revenue is recognized upon shipment or delivery of
goods when title and risk of loss are passed to the customers. For Kraft, shipping and
handling costs are classified as part of cost of sales. When dealing with inventory, Kraft
along with its competitors use the LIFO accounting method for a majority of its
domestic inventories. For Kraft, the cost of other inventories is determined using the
average cost method. The industry uses the straight line method for depreciation of
property, plant, and equipment. However, the useful lives used for depreciation will
vary from asset to asset and company to company.
Though the companies are similar, Kraft has made some recent changes in the Stock
Options department. In 2005 stockholders approved the Kraft 2005 Incentive Plan. With
this plan, Kraft may grant to eligible employees awards of stock options, stock
appreciation rights, restricted stock, and other awards based on Kraft’s Class A common
stock. A maximum of 150 million shares of Kraft Class A common stock may be issued
under this new plan. Kraft applies the intrinsic value-based method in accounting for
the various stock plans. Compensation expense is what is recognized for the restricted
stock awards. In 2004, the FASB issued SFAS No. 123 a.k.a. “Share-Based Payment”.
(Kraft 2005 10K). It requires companies to measure compensation cost for share-based
payments at fair value. Kraft adopted this new standard on January 1, 2006; fortunately
it will not have a material impact on its consolidated financial position, results of
operations or cash flows.
With regards to Kraft’s key success factors, the “2005 plan” directly relates to having
employees who show integrity and efficiency in the workplace. This plan encourages
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employees to do just that. With more efficiency in the workplace the lower production
costs will be and will result in higher profits.
Qualitative and Quantitative Analysis
Qualitative and quantitative factors were used when determining the quality of Kraft’s
quality disclosures. The tables below are the sales and core expense manipulation
diagnostics tables. They contain three ratios each for the past five years (2001-2005).
Kraft (sales)
2001
2002
2003
2004
2005
0.9966
0.9995
1.0084
1.0054
0.9954
9.3370
9.5388
9.0525
9.0844
10.0777
9.6609
8.7886
9.1229
9.3322
10.2043
Net Sales / Cash from Sales
Net Sales / Accounts Receivable
Net Sales / Inventory
Kraft’s net sales to cash from sales ratio has hovered around 1 for the past five years
with a slight rise in 2003-2004, but then declining again in 2005. This could be a
potential red flag; however, it is best to compare it with the industry to see if it is just
within Kraft, or an industry change. There also may be concern with the net sales to
accounts receivable ratio. It was increasing from 2001-2002, but then began to
decrease, and then increased again in 2005. The increase in 2005 could be caused by
a decrease in accounts receivables for that year. The net sales to inventory ratio has
continued to increase with just a slight decrease in 2002. Again, it is necessary to look
at the industry analysis before raising concern.
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The following tables are the sales manipulation diagnostics for two competitors, Sara
Lee and ConAgra Foods.
Sara Lee (sales)
2001
2002
2003
2004
2005
Net Sales / Cash from Sales
0.9866
1.0169
0.9975
1.0032
1.0101
Net Sales / Accounts Receivable
10.8140
9.6275
10.0101
10.3458
9.4382
Net Sales / Inventory
6.4415
7.0259
6.7451
7.0084
7.1470
ConAgra Foods (sales)
2001
2002
2003
2004
2005
Net Sales / Cash from Sales
1.0147
0.9855
0.9720
1.0370
0.9992
Net Sales / Accounts Receivable
15.6101
17.4988
20.6438
10.8064
11.274
Net Sales / Inventory
4.9415
5.4783
6.7330
5.5958
5.5716
Comparing Kraft with Sara Lee and ConAgra Foods will help to determine whether or
not there is an industry change or a potential red flag within Kraft. In the net sales to
cash from sales ratio, both the industry and Kraft has hovered around one. They have
all increased and decreased a little bit throughout the years proving that this is mostly
due to a change within the industry. Kraft seems to be moving in an opposite direction
with the net sales to accounts receivable ratio. This could be a potential red flag for
Kraft. Kraft’s net sales to inventory ratio seems to be increasing and decreasing along
the same lines as the industry confirming that it is a change with in the industry. All of
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these ratios are fairly consistent with the industry verifying that Kraft is most likely not
manipulating their sales numbers.
Net Sales / Cash from Sales
1.06
1.04
1.02
Kraft
1
Sara Lee
0.98
ConAgra
0.96
Industry Average
0.94
0.92
2001
2002
2003
2004
2005
Net Sales / Accounts Receivables
25
20
Kraft
15
Sara Lee
10
ConAgra
Industry Average
5
0
2001
2002
2003
2004
2005
Net Sales / Inventory
12
10
8
Kraft
6
Sara Lee
4
ConAgra
2
0
2001
2002
2003
2004
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2005
It is also important to compare the core expense diagnostics. Below is Kraft’s core
expense manipulation diagnostics:
Kraft Foods Inc.
Sales / Assets
Changes in CFFO / OI
Changes in CFFO / NOA
2001
2002
2003
2004
2005
0.52
0.52
0.51
0.54
0.59
0.02
0.06
0.07
(0.02)
(0.11)
0.01
0.06
0.05
(0.01)
(0.07)
Some factors stand out in these ratios. First the negative results in the last two ratios,
as well as some inconsistency in the last two ratios. In the sales to assets ratio, the
numbers are fairly consistent with a slight increase in 2005. This could either be to an
increase in sales or a decrease in assets. In 2004 and 2005, the changes in cash flow
from operations were negative. This caused the negative ratios in changes in cash flow
from operations to operating income and net operating assets.
In order to determine if Kraft’s ratios were in line with its competitors, it is best to
compare them with the competitors in their industry. Below are the core expense ratios
for Sara Lee and ConAgra Foods.
2001
2002
2003
2004
2005
Sales / Assets
1.64
1.28
1.15
1.29
1.34
Changes in CFFO / OI
(0.02)
0.20
0.06
(0.01)
0.18
Sara Lee
Changes in CFFO / NOA
(0.02)
0.11
- 22 -
0.03
(0.01)
0.06
ConAgra Foods Inc.
2001
2002
2003
2004
2005
Sales / Assets
1.52
1.44
1.10
0.99
1.14
Changes in CFFO / OI
(0.50)
1.77
(1.26)
(0.08)
0.46
Changes in CFFO / NOA
(0.30)
1.42
(0.95)
(0.05)
0.35
When comparing the industry’s sales to asset ratio to Kraft, they all seem to be fairly
consistent with a slight increase in 2005. However, Kraft’s sale to asset ratio is a lot
smaller than the industry. This is because Kraft’s assets are nearly double of what their
sales are each year. The changes in cash flow from operations to operating income and
net operating assets ratios seem to be steady in year 2004. For each company they are
all negative ratios, which could be a result of an industry change. However, all the
ratios for each company seem a little bit irregular from each other making it a difficult
to make any conclusions about the industry average.
Sales / Assets
2
Kraft
Sara Lee
ConAgra
Industry Average
1.5
1
0.5
0
2001
2002
2003
2004
- 23 -
2005
Changes in CFFO / OI
2
1.5
1
Kraft
0.5
Sara Lee
0
ConAgra
-0.5
2001
2002
2003
2004
Industry Average
2005
-1
-1.5
Changes in CFFO / NOA
2
1.5
Kraft
1
Sara Lee
0.5
0
-0.5
ConAgra
2001
2002
2003
2004
2005
-1
-1.5
Quality of Disclosure
Kraft Foods Inc. is very thorough in their business section of the 10-K. They break
down segments of their company such as, beverages, cheese, convenient meals,
snacks, and cereals, in North America and Internationally. This gives even greater
detailed information about the condition of their company in each of these segments.
They also disclose information about threats of competitors within the American and
International market. They explain how they plan to increase their advertising to
improve their brand image, which helps gain a competitive advantage over other
- 24 -
companies. Kraft also discusses their three-year restructuring program. This program
is designed to improve its cost structure and consumption of assets.
Kraft’s footnotes of their financial information are specific in explaining the way that
they report their employee benefit and postretirement plans, goodwill, and income
taxes. They also disclose how they handle their foreign exchange rates. Kraft uses
forward foreign exchange contracts to alleviate any changes in exchange rates.
Overall Kraft reports a good quality of disclosures on their 10-K statements.
Potential “Red Flags”
In order to evaluate Kraft’s accounting procedures, it is important to look for potential
“red flags” that might catch an analyst’s eye within the firm. As discussed earlier in the
previous qualitative and quantitative factors, Kraft has certain issues that might be
looked into further as far as accounting policy goes. However, this is no cause for
alarm. Kraft has been involved in certain changes within the organization that have led
them to slight ups and downs in regard to their financials. The company justifies these
changes by thoroughly disclosing all the potential “red flag” information within the
Management’s Discussion and Analysis of Financial Condition section of the 10-K. For
example, Kraft’s internal restructurings have affected the net impact of lower asset
impairment, exit and implementation costs on earnings, and diluted earnings per share
from continuing operations. Kraft consistently explains the affect of these
circumstances within their financials and the value to which they were incurred. This in
return eliminates any further suspect within the firm in regard to US GAAP. In
comparison to the industry, Kraft continues to fade away from potential suspicion due
to their high market share, consistent revenues, and their superior brand loyalty. (Kraft
2005 10K)
- 25 -
As stated before, Kraft has chosen to go with a more conservative approach to their
accounting methods. All of which comply with the U.S. GAAP regulations and
procedures. Kraft uses the LIFO method for their domestic inventory. This means that
they have a lower net income and therefore pay fewer taxes on that income. As stated
in the Accounting Strategy section, Kraft recognizes its revenue upon shipment or
delivery of goods. This strategy helps lower the risk and cost of lost goods to the
company; because, they recognize the revenue only after that risk is transferred to the
customer. Kraft has also been very informative about their new retirement and
incentive plan. With Kraft’s high level of disclosure about their accounting methods and
everything that goes into their 10-K reports, there is little room to be able to accuse
Kraft of falsifying their financial reports.
- 26 -
Financial Statement Ratio Based Analysis
The purpose of this section is to review the financial ratios for Kraft in the past five
years, as well as forecast the following ten years of financial statements. Using these
ratios it is possible to analyze Kraft’s past and present performance in order to look for
any possible trends in the company. There are several different methods for
performance of measures that are used in the ratio analysis which include liquidity,
operating efficiency, profitability, and capital structure. From these ratios we will be
able to determine the company’s overall standing in the food produce industry and
evaluate its progress over time.
In the following sections, the basic 14 ratios will be used when assessing Kraft’s
performance in the areas of liquidity, operating efficiency, profitability, and capital
structure. Also, the forecast of the next ten years will help us to determine in what
direction the company is headed and what can be done to continue these positive
trends and/or remove the negative ones. This analysis is vital to Kraft because it
provides its investors with public information that gives them the ability to compare
with other competitors in its industry.
Ratio Analysis
Financial statement analysis helps to evaluate management performance and trends
within the company. Kraft’s analysis was broken down into four major areas: liquidity,
operating efficiency, profitability, and capital structure.
Liquidity ratios explain how liquid the company actually is. They try to measure the
firm’s ability to pay back their current liabilities. In Kraft the current ratio was
increasing until 2005, when there was a negative change. This was due to the
- 27 -
decrease in current assets in 2005. There was essentially no change in the quick asset
ratio in the past two years.
Operating efficiency measures how efficient the firm is in terms of their operations
management. Kraft’s accounts receivable ratio increased in year 2005. This increase
reduced the number of days’ sales outstanding, which helped Kraft become more
efficient because there was less accounts receivable tied up. Inventory turnover acted
in the same way as the receivables turnover. Working capital turnover seems to be the
most unstable. The changes in working capital are mostly because of the changes in
current assets and current liabilities.
The profitability analysis measures how profitable a firm is in terms of sales and net
income. For Kraft, the gross profit margin and net profit margin decreased in 2004 due
to an increase in sales. The operating expense ratio began to decrease in 2002. This
was probably also caused by an increase in sales each year. Asset turnover remains
stable, with a slight increase in 2005. Return on assets and return on equity also began
to decrease in 2004 because of a decrease in net income from the previous years.
Capital structure analysis is the last area examined in financial statement analysis. This
refers to the companies sources of financing. The debt to equity ratio has been
decreasing each year. This is a good thing because this indicates that debt has become
a smaller proportion of the total financing. Times interest earned has greatly increased
since 2001. This ratio shows the sufficiency of income from operations to cover
required interest charges. The debt service margin measures how much of cash that is
provided by operation that will cover the annual payments on long-term liabilities.
There was a big increase in 2002, but then has been decreasing since then. (Kraft
2005 10K)
- 28 -
CROSS-SECTIONAL ANALYSIS
Liquidity Ratios
Current Ratio
This ratio is very important in analyzing a company’s liquidity. Kraft shows that they are
constantly around a ratio of one. Compared to the industry, Kraft usually has the lowest
ratio. This means that they usually have just enough current assets to cover their
current liabilities. Their competitors and the industry show more liquidity with higher
current ratios.
Current Ratio
2
Kraft
Values
1.5
Sara Lee
1
ConAgra Foods
0.5
Industry Avg.
0
2001
2002
2003
2004
2005
Years
Quick Asset Ratio
Looking at the graph, we can see that the industry as a whole as increased from year to
year since 2001. Kraft increased with the industry until 2003. Then they decreased a
bit, and leveled off in 2005. In terms of liquidity, Kraft doesn’t vary too much, but
recently has been the lowest in the industry.
Quick Asset
Ratio
Values
0.8
Kraft
0.6
Sara Lee
0.4
ConAgra Foods
0.2
Industry Avg.
0
2001 2002 2003 2004 2005
Years
- 29 -
Inventory Turnover
From this graph, we can see that the all the firms in the industry stay fairly close to
each other. Kraft definitely shows the highest of the firms, and has increased in recent
years. This means that Kraft would have a lower days supply of inventory than the rest
of their competitors and the industry. In 2005, their days supply of inventory is 55.9.
This means that they have enough in inventory to cover almost 56 days of supplies to
the consumers.
Inventory Turnover
Values
8
Kraft
6
Sara Lee
4
ConAgra Foods
2
Industry Avg.
0
2001
2002
2003
2004
2005
Years
Accounts Receivable Turnover
This graph shows that Kraft and Sara Lee’s turnover ratio are the lowest. This means
that they do not have a lot of cash from sales. Most of their sales are put on account.
ConAgra Foods is by far the highest, and they move in the same directions as the
industry. The lower turnover ratios for Kraft and Sara Lee will result in higher days sales
outstanding. Kraft’s days sales outstanding are 36.21 for 2005. This means that Kraft
has credit sales outstanding for about 36 days.
Values
Accounts Receivable
Turnover
25
20
15
10
5
0
Kraft
Sara Lee
ConAgra
Foods
2001 2002 2003 2004 2005
Years
- 30 -
Industry Avg.
Working Capital Turnover
From this graph, one can see that the firms are sporadic in their respective turnovers.
This is mostly contributed to the varying current ratios. Kraft usually moves against the
other firms in the industry. In recent years, Kraft has dropped below their competitors.
This shows again that Kraft’s liquidity is lower than that of their competitors and the
industry.
Values
Working Capital
Turnover
200
150
100
50
0
-50
-100
2001 2002 2003 2004 2005
Kraft
Sara Lee
ConAgra Foods
Industry Avg.
Years
Profitability Ratios
Gross Profit Margin
Kraft and Sara Lee show the highest margins, and they seem to move together. Kraft’s
high margin is a good sign, in that they receive more profit on each sale than some of
the other firms. This is good for profitability and operating efficiency.
Gross Profit
Margin
50.00%
Values
40.00%
Kraft
Sara Lee
ConAgra Foods
Industry Avg.
30.00%
20.00%
10.00%
0.00%
2001 2002 2003 2004 2005
Years
- 31 -
Operating Expense Ratio
From this graph, one can see that firm’s ratios are spread out. Kraft is the lowest by far.
This shows that Kraft has found ways to cut down on their SG&A expenses. This leads
to more profit on each sale. One way that Kraft could have lowered their expenses is by
spreading their expenses out over more operations.
Operating Expense
Ratio
Kraft
Sara Lee
ConAgra Foods
Industry Avg.
20
01
20
02
20
03
20
04
20
05
Values
40.00%
30.00%
20.00%
10.00%
0.00%
Years
Net Profit Margin
This graph shows that in the recent years, Kraft is definitely outperforming the industry.
This means that Kraft is able to retain more of its sales in net income than the rest of
the industry. This is a big key to a profitable firm that wants to grow.
Values
Net Profit Margin
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
Kraft
Sara Lee
ConAgra Foods
Industry Avg.
2001 2002 2003 2004 2005
Years
- 32 -
Asset Turnover
The competitors and industry average move together; while Kraft stays at the very
bottom of the industry. This can be attributed to Kraft not holding as many assets as
the other firms. This assumption can also be seen with the low current ratios stated
earlier.
Asset Turnover
2
Values
1.5
Kraft
Sara Lee
ConAgra Foods
Industry Avg.
1
0.5
0
2001 2002 2003 2004 2005
Years
Return on Assets
From this ratio, one can see that in the more recent years the industry moves together.
With the low asset turnover and current ratios, Kraft again is towards the bottom of the
industry.
Return on Assets
25.00%
Values
20.00%
Kraft
Sara Lee
ConAgra Foods
Industry Avg.
15.00%
10.00%
5.00%
0.00%
2001 2002 2003 2004 2005
Years
- 33 -
Return on Equity
With the last profitability ratio, one can see Kraft and ConAgra Foods are very similar.
In more recent, years the industry has moved more towards them at the bottom. This
shows that Kraft’s investors do not get as much of a return on their investment as what
other investors get from the other companies in the industry.
250.00%
200.00%
150.00%
100.00%
50.00%
0.00%
Kraft
20
05
20
04
20
03
20
02
Sara Lee
20
01
Values
Return on Equity
ConAgra
Foods
Industry Avg.
Years
Capital Structure Ratios
Debt to Equity
From this graph, one can see that the companies started off in different areas, but have
all pretty much moved with the industry to lower levels. Kraft has decreased a little, but
definitely remains at the bottom. This means that Kraft has higher equity compared to
its liabilities than the rest of companies in the industry. Kraft certainly has the best
ratio.
Debt to Equity
10
Kraft
Values
8
6
Sara Lee
4
ConAgra
Foods
2
0
2001 2002 2003 2004 2005
Years
- 34 -
Industry Avg.
Times Interest Earned
For the most part the industry moves together except for Kraft. In more recent years,
Kraft maintains the highest ratio in the industry. This shows that Kraft has the most
operating income to cover its interest expense.
Times Interest
Earned
10
Kraft
Values
8
6
Sara Lee
4
2
0
2001 2002 2003 2004 2005
ConAgra
Foods
Industry Avg.
Years
Debt Service Margin
Overall, Kraft definitely moves with the industry trends. Kraft started out with the
highest ratio, but has recently fallen to the middle of the industry. This means that Kraft
used to have plenty of income from operations to cover its current installments on longterm debt, but more recently has had either its income go down or its current
installments on long-term debt go up.
Debt Service Margin
20
Kraft
Values
15
Sara Lee
10
ConAgra
Foods
Industry Avg.
5
0
2001 2002 2003 2004 2005
Years
- 35 -
Liquidity
Kraft seems to not be very liquid. We can see this most when we look at the current
and quick asset ratios. These mainly deal with the most liquid assets, and Kraft is
towards the bottom of the industry. They do have a bright spot in the inventory
turnover though. The increase and being the highest in the industry is very favorable
for their liquidity. When we look at the account receivable turnover, we go back to the
same story of Kraft not being very liquid. With the working capital turnover, we saw the
Kraft usually moved against the trends and was the highest in the industry for a while,
but in more recent years, Kraft has fallen to the bottom.
Profitability
Kraft’s profitability is a totally different story than its liquidity. Kraft shows strong gross
profit margins and net profit margins compared to the industry. Team that up with the
lowest operating expense ratio, Kraft looks to be a very profitable company. Kraft hits a
little bit of a snag with their asset turnover, return on assets, and return on equity.
Kraft performs at the bottom of the industry in all three of these ratios, but the industry
has moved down towards Kraft in the recent years. Overall, Kraft seems to be a fairly
profitable company within the industry.
Capital Structure
For the most part, Kraft’s capital structure seems pretty steady within the industry.
They have the lowest debt to equity ratio. This means that their debt is usually paid off
in a timely manner. Kraft’s times interest earned is definitely higher than the industry
which is not a great thing for the investors. Until recent years, Kraft has had a high
debt service margin compared to the industry. This would indicate that Kraft usually has
plenty of income from operations to cover current payments on their long-term debt.
That is a good key to any strong capital structure. (Sara Lee 2005 10K and ConAgra
2005 10K)
- 36 -
Forecast Financial Statements and Analysis
Income Statement Analysis
In order to forecast Kraft for the next 10 years, it is important to recognize the internal
growth rate and sustainable growth rate calculations. The equations used to calculate
are: IGR = ROE(1 - Dividend Payout Ratio) and SGR = IGR(1 + D/E).
Kraft
ROE
2001
.080
2002
.131
2003
.121
2004
.090
2005
.090
Dividend Payout Ratio
.119
.276
.313
.480
.546
SGR
15%
21%
17%
9%
8%
IGR
7%
9.5%
8.3%
4.7%
4.1%
The average IGR and SGR for the five years is 6.72% and 14%. The separate IGR and
SGR percentages are distributed evenly around their respective averages. It is easy to
see the common fluctuations as far as growth is considered for a large major foods
diversified company. Due to Kraft’s size, it is very uncommon for sales to significantly
increase or decrease from year to year. From 2001 to 2005, Kraft has gradually
increased their revenue at a very slow rate. Again, we believe sales will not change
very much due to the large market share that Kraft owns and the steady rate we’ve
observed from the past five years. Ultimately, we believe Kraft will continue to have
similar sales growth for the next 10 years. These assumptions are confirmed with the
above noticed SGR and IGR rates for Kraft foods.
Kraft’s costs of sales have also been very similar for the past five years. Their
marketing, research, and administration costs have increased slightly. Due to our
research, a large change is not forecasted for these costs over the next 10 years.
Gross profit forecasts are calculated by subtracting these cumulative costs minus net
sales forecasts. Marketing, research, and administration costs are calculated as a
percentage of net sales for the next 10 years.
- 37 -
In order to calculate earnings projections, we subtracted our marketing, administration,
and research costs from our forecasted gross profit outlook. These earnings numbers
should reflect close to around 15-20% of net sales.
Interest and other debt expense represent a very small percentage of net sales. For
example, over the past 5 years, the ratio never surpassed more than 5%. Next, our
forecasted net profit margin for the next 10 years came near 10%. This was calculated
using the average margin of the last 5 years.
In order to round up our income statement analysis, net income was calculated by
multiplying our suggested net sales by our net profit margin of 10%.
Balance Sheet Analysis
A very similar analysis was used to determine our balance sheet forecasts as the
income statement. Raw material and finished product inventories have been extremely
close numbers for the past 5 years. We believe this is because Kraft should not have to
change their work in progress if they are already a top leader in the industry. This is
represented in the inventory forecast as well. Inventory makes up about 5% of total
assets for Kraft. In order to forecast total assets, we used our forecasted sales
numbers and divided that by the asset turnover ratio. These reflections will continue to
be similar due to the analysis of the SGR.
Current liabilities also have very small changes over the past 5 years. A noticeable
outlier would be an increase from 2004 to 2005 in current portion of long term debt
outstanding. As far as non-current liabilities are concerned, the balance has not
changed more than 5% up or down. Thus, total liabilities have not changed very much
in the past five years either. Our forecasts show a minimal change in liabilities for Kraft
in the next 10 years.
- 38 -
To continue Kraft’s minimal change trend, Owner’s equity has increased slightly over
the past 5 years. By dividing total liabilities by the debt to equity ratio our forecasts
show a continual small increase in the equity account in regard to shareholders.
Balance sheet data is present at the end of the report.
Statement of Cash Flows Analysis
Kraft provides similar changes once again with cash provided from operating activities.
The small change from the previous 5 years again backs up the understanding that
Kraft doesn’t need to change their internal processes to adapt to the market. Cash
from investing activities shows negative balances from 2001 to 2004. However in 2005
due to a purchase of businesses, the balance fell back to positive. Unless Kraft decides
to acquire more companies in the near future, the balance should remain somewhat
unchanged for 2005 to 2015. Financing activities also show negative balances. A
gradual decrease for the past 5 years shows forecasts to remain similar for the next 10
years.
- 39 -
Equity Valuation Analysis
In the valuation of Kraft, Inc. we evaluated the company using intrinsic valuation
methods and came to the conclusion that the firm’s share price is overvalued. With the
several valuation models, we were able to come up with a relevant value of the
company. In order to start evaluating, the methods of comparables were calculated.
After that, the discounted dividends, discounted free cash flows, residual income, longrun residual income, and abnormal earnings growth models were used as well to value
Kraft. With the use of these several valuation methods, our value of the firm was
accurately determined.
Methods of Comparables
According to our knowledge of price multiples, this valuation method is relatively
simplistic and easy to implement. We used four different performance measures to
calculate the firm’s value: earnings per share, book value per share, dividends per
share, and price per share. Kraft’s main competitors are Con Agra and Sara Lee. We
used these two companies to compare Kraft’s value according to the comparables
method.
2004
EPS
BPS
DPS
PPS
Kraft Foods Inc.
1.87
17.54
0.75
35.61
Sara Lee
1.59
3.71
0.75
46.08
ConAgra
1.5
9.3
1.03
29.45
2005
EPS
BPS
DPS
PPS
Kraft Foods Inc.
1.88
17.72
0.85
28.21
Sara Lee
1.36
3.74
0.78
36.95
ConAgra
1.35
9.38
1.07
20.28
- 40 -
Comparables (KFT) P/E Trailing P/E Forecast
Kraft's Price (2004)
$19.04
$39.44
Kraft's Price (2005)
$15.01
$39.20
Industry Avg. (2004)
24.31
21.09
Industry Avg. (2005)
21.09
20.85
P/B
$136.64
$106.67
7.79
6.02
D/P
$25.86
$22.97
0.029
0.037
P/S
$27.54
$22.68
1.46
1.11
PEG
P/EBIT P/EBITDA
M/B
$20.09
$35.11
$84.37 $ 2.03
$19.86
$29.47
$71.59 $ 1.59
0.341
13.01
12.98
3.78
0.1475
10.34
10.36
3.07
According to our data, Kraft’s P/E trailing price for 2004 and 2005 is less than the
industry average. Also, our forecasts show that Kraft price to earnings will increase.
However, the industry forecasts based on the averages will decline respectively. It is
significant to note that Kraft has larger earnings per share in the year 2004 and 2005
compared to its competitors. Also, book value per share is larger than the Kraft’s two
main competitors. As for dividends per share and price per share, Kraft fits right in the
middle with Con Agra and Sara Lee.
It is consistent to notice that Kraft has similar yet more impressive calculations as far as
their financial ratios are concerned. Although, we believe that Kraft is still overvalued
according to the rest of our data that we have collected. It’s easy to compare Kraft’s
financial ratios with its competitors and industry but in order to truthfully value the firm,
more information is needed to make a final decision. (Kraft Value Line; November 3,
2006) (www.yahoo.finance.com)
Intrinsic Evaluations
Discounted Dividends Method
In order to analyze Kraft based on the Discounted Dividends Model, it is important to
first recognize the cost of equity of the firm and dividends in the future. According to
our forecasted data, our dividends are shown to grow at an increasing rate for the next
10 years as well as the terminal period. Cost of Equity is 6.97%. Based on our
- 41 -
gathered data, growth and dividends have a high correlation between each other. In
other words, observable increases in firm value should also increase dividends
respectively. Our estimated value per share in the year 2005 is $26.06. The market
value per share is $34.36. Therefore, according to the discounted dividends model,
Kraft seems tends to look overvalued. However, as we continue to analyze Kraft with
other valuation models, we will come up with a final decision after all models have been
looked into.
Sensitivity Analysis
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0
$105.51
$68.95
$50.75
$39.89
$32.70
$27.60
$23.80
$20.87
0.01
$197.60
$97.04
$63.62
$46.97
$37.03
$30.44
$25.76
$22.27
g
0.03
N/A
N/A
$166.54
$82.35
$54.34
$40.37
$32.02
$26.47
0.05
N/A
N/A
N/A
N/A
$140.92
$70.19
$46.63
$34.87
0.07
N/A
N/A
N/A
N/A
N/A
N/A
$119.69
$60.07
0.09
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
According to our sensitivity analysis, it’s hard to believe that the discounted dividends
model is the most accurate way of valuing the firm. As stated earlier, other valuation
methods give a better look at the firm in order to overvalue or undervalue Kraft, Inc.
Free Cash Flows
Along with the discounted dividends model, the free cash flows method has two
components to look into in order to find a worthy valuation. These two components are
the weighted average cost of capital and the future free cash flows of the firm. Along
with dividends, we estimate that Kraft’s free cash flows will also continue to increase at
a slow rising rate for the next 10 years. This is calculated by subtracting cash flow from
investing activities from cash flow from operations. The weighted average cost of
capital is 6.77%. The total present value of free cash flows totals near $20 billion
dollars. This is found by adding all the annual cash flows from 2005 all the way to
- 42 -
2015. Also the terminal value of continuing growth throughout the years is near $27
billion dollars.
Sensitivity Analysis
g
WACC
0.020
0.025
0.030
0.035
0.040
0.045
0.050
0.055
0.060
0.065
0.070
0
0.01
0.02
0.03
0.04
0.05
$103.59
$82.66
$68.72
$58.77
$51.31
$45.52
$40.90
$37.12
$33.98
$31.32
$29.05
$191.20
$127.35
$95.44
$76.30
$63.55
$54.45
$47.63
$42.33
$38.09
$34.63
$31.75
N/A
$350.81
$175.62
$177.22
$88.03
$70.52
$58.85
$50.52
$44.27
$39.41
$35.53
N/A
N/A
N/A
$321.82
$161.47
$108.02
$81.29
$65.26
$54.57
$46.93
$41.20
N/A
N/A
N/A
N/A
N/A
$295.51
$148.62
$99.65
$75.16
$60.46
$50.65
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$271.60
$136.93
$92.02
$69.56
According to our sensitivity analysis, as the weighted average cost of capital and growth
rise, prices remain rather sensitive. Although, when using the free cash flows model, it
is common to conclude that large changes in prices occur often. As for the free cash
flows model as a method of valuation, it is imperative to look at the remaining valuation
methods to conclude whether Kraft is over and under valued.
Residual Income
Our third intrinsic valuation method is the residual income model. This model is based
upon accounting data relating to book value, dividends, and earnings of the firm.
These values are all based upon a per share basis. In relation to the two previous
methods, two components are used to find residual income. Cost of equity of the firm
and earnings per share are these components. Earnings per share are forecasted to
increase over the next 10 years. Book value per share increases as well over the
forecasted time period. Average return on equity is valued at approximately 8.5%.
The estimated value in 2005 and 2006 both reflect that Kraft is overvalued. The actual
market price is $34.36. The 2005 and 2006 values are $25.55 and $26.28 respectively.
- 43 -
Sensitivity Analysis
G
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
0.11
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
$83.69
$55.20
$40.31
$32.45
$26.78
$22.74
$19.72
$17.38
$15.52
$13.99
$138.22
$69.28
$46.26
$34.73
$27.79
$23.16
$19.84
$17.35
$15.40
$13.84
N/A
$111.52
$56.84
$38.53
$29.31
$23.74
$20.00
$17.30
$15.26
$13.66
N/A
N/A
$88.59
$46.13
$31.84
$24.61
$20.21
$17.24
$15.07
$13.42
N/A
N/A
N/A
$68.92
$36.90
$26.07
$20.54
$17.15
$14.83
$13.13
N/A
N/A
N/A
N/A
$52.09
$28.98
$21.09
$17.02
$14.49
$12.73
$1.91
N/A
N/A
N/A
N/A
$37.71
$22.18
$16.80
$13.97
$12.17
$7.36
$5.92
$3.94
$0.54
N/A
N/A
$25.46
$16.36
$13.11
$11.34
$10.99
$10.14
$9.23
$8.14
$6.54
$2.79
N/A
$15.05
$11.39
$9.95
According to our sensitivity analysis, cost of equity of Kraft must fall to 3% and growth
must fall to 1% in order to remain at market price. The discounted dividends model,
free cash flows model, and residual income model all conclude that Kraft is overvalued.
We now begin to see an ongoing trend with Kraft.
Long Run Residual Income Perpetuity
P=BVE+BE ((ROE-Ke)/(Ke-g))
In order to analyze Kraft based upon the long run residual income perpetuity method,
there are a few components to consider. These components are the book value of
equity per share which is $17.72. Next, return on equity has a value of 8.4%. Thirdly,
cost of equity is 6.97%. Fourth, the growth rate is 4%. Finally our estimated price per
share that we came up with is $26.52. The long run residual income valuation is rather
important to consider. According to our knowledge, this particular valuation tool is used
often when valuing firms. This is because the margin for incorrect forecasting is smaller
than the previous methods. However, not by any means are we jumping to conclusions
regarding the valuation of Kraft. Although, once again we notice that Kraft is
overvalued according to the number compiled with this valuation model.
- 44 -
Sensitivity Analysis
g
0
0.01
0.02
0.03
$74.84 $131.95
N/A
N/A
$49.89
$65.98 $114.23
N/A
$37.42
$43.98
$57.12 $96.51
$29.93
$32.99
$38.08
$48.26
$24.95
$26.39
$28.56
$32.17
$21.38
$21.99
$22.85
$24.13
$18.71
$18.85
$19.04
$19.30
$16.63
$16.49
$16.32
$16.09
$14.97
$14.66
$14.28
$13.79
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
Ke
0.04
N/A
N/A
N/A
$78.79
$39.40
$26.26
$19.70
$15.76
$13.13
0.05
N/A
N/A
N/A
N/A
$61.07
$30.54
$20.36
$15.27
$12.21
Abnormal Earnings Growth
Evaluating Kraft by using this particular model gives the firm the opportunity of
reinvesting the company’s dividends. In order to find this number of dividends to
reinvest, we subtracted normal earnings from cumulative-dividend earnings. Our
abnormal earnings growth from 2005 to 2015 starts off deteriorating but then starts to
increase after 7 years.
Sensitivity Analysis
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
-0.08
$93.45
$61.36
$45.33
$35.73
$29.34
$24.80
$21.41
$18.78
g
-0.06
$95.89
$62.73
$46.20
$36.33
$29.77
$25.12
$21.65
$18.96
-0.04
$99.96
$64.89
$47.51
$37.19
$30.37
$25.55
$21.97
$19.21
-0.02
0
0.02
$108.09 $132.49
N/A
$68.76
$77.81 $123.02
$49.69
$54.05 $67.14
$38.54
$40.98 $46.66
$31.27
$32.76 $35.75
$26.17
$27.15 $28.91
$22.41
$23.09 $24.21
$19.54
$20.02 $20.77
0.04
N/A
N/A
N/A
$75.08
$44.72
$33.02
$26.45
$22.13
According to our sensitivity analysis, growth and cost of equity must both increase for
Kraft to be at market price. Once again, we realize that the firm is observably
overvalued. The abnormal earnings growth model is also considered to be rather
- 45 -
accurate. Along with each other valuation method, Kraft is noticeably overvalued
according to our calculations.
Risk Analysis
In order to compute the credit risk for Kraft, a popular method was used called the
Altman Z-score. This particular score is based upon ratios that are derived from certain
sections of the financials. According to our calculations, Kraft has a Z-score of 2.089 in
2005 and 2.123 as an average of the past five years. Therefore, Kraft has a moderate
Z-score rating. This isn’t necessarily a terrible rating for Kraft because it is in between
low and high risk. In regard to Kraft’s credit rating in the industry, it has room to
improve but they aren’t by any means in danger of financial grief.
- 46 -
Valuation Conclusion
According to our knowledge as analysts, it is vital to evaluate Kraft’s price through the
use of intrinsic valuation models. Due to our forecasts, it is apparent that our data
could be less than perfect. However, the numbers we have calculated are disclosed
with the best of our abilities. Each significant factor that we have compiled such as
Cost of Equity, Cost of Debt, Weighted Average Cost of Capital, and each other
valuation method contain forecasts carefully evaluated by our team. According to our
research, we recognize that Kraft, Inc. is an overvalued firm. All of our valuation
models confirm our analysis of the company.
While showing poor liquidity compared to the industry, Kraft can still boast about good
profitability and capital structure. We feel their good profitability and capital structure is
due to them already having a firm grip on a big share of the industry. Kraft’s
established place in the market helps keep the profitability and capital structure steady.
In this highly competitive market full of substitutes, it is imperative to have a loyal
customer base. Kraft achieves this base with a superior brand image and quality of
service. Even with our forecasts of success in the future, we still feel that Kraft is
overvalued due to our analysis of the intrinsic valuation methods. Since we feel Kraft is
overvalued within the industry, we recommend selling the stock. However considering
our forecasted upward trend in the future, we feel with an investment horizon of more
than five years that Kraft would not be detrimental to a portfolio.
- 47 -
APPENDIX
Appendix A.
Core Financial Ratios
Appendix B.
Forecasted Financials
Forecasted Balance Sheet
Common Sized Balance Sheet
Forecasted Income Statement
Common Sized Income Statement
Forecasted Statement of Cash Flows
Financial Ratios
Appendix C.
Cost of Capital
Cost of Equity
Weighted Average Cost of Debt
Weighted Average Cost of Capital
Appendix D.
Valuation Models
Discounted Dividends
Free Cash Flows
Residual Income
Long-Run Residual Income Perpetuity
Abnormal Earnings Growth
Appendix E.
Core Manipulations
- 48 -
Appendix A.
Core Financial Ratios
Current Ratio
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
0.79
1.03
1.06
1.05
2002
1.04
0.91
1.49
1.20
2003
1.03
1.15
1.59
1.37
2004
1.07
1.06
1.71
1.39
2005
0.93
1.17
1.89
1.53
Quick Asset Ratio
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
0.37
0.42
0.26
0.34
2002
0.46
0.39
0.36
0.38
2003
0.49
0.55
0.42
0.49
2004
0.42
0.47
0.66
0.57
2005
0.42
0.52
0.63
0.57
A/R Turnover
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
9.34
10.81
13.21
15.61
2002
9.54
9.63
13.57
17.50
2003
9.05
10.01
15.33
20.64
2004
9.08
10.35
10.58
10.81
2005
10.08
9.44
10.36
11.27
Inventory Turnover
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
5.81
3.98
4.60
4.29
2002
5.24
4.27
5.47
4.87
2003
5.54
4.09
4.89
4.49
2004
5.88
4.32
4.31
4.32
2005
6.53
4.56
4.39
4.48
Working Capital Turnover
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
-15.64
141.98
63.69
102.84
2002
103.56
-36.96
13.03
-11.97
2003
115.96
24.26
8.79
16.53
2004
49.95
60.58
6.78
33.68
2005
-59.74
22.84
6.82
14.83
Gross Profit Margin
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
39.91%
42.20%
14.30%
28.25%
2002
40.38%
39.30%
14.80%
27.05%
2003
39.24%
39.60%
19.30%
29.45%
2004
36.95%
38.60%
22.00%
30.30%
2005
35.96%
36.20%
21.30%
28.75%
- 49 -
Operting Expense Ratio
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
4.92%
33.00%
8.70%
20.85%
2002
2.85%
30.40%
8.80%
19.60%
2003
2.18%
30.40%
11.60%
21.00%
2004
2.07%
30.10%
12.50%
21.30%
2005
1.86%
28.70%
12.60%
20.65%
Net Profit Margin
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
6.44%
12.80%
2.30%
7.55%
2002
11.42%
5.70%
2.80%
4.25%
2003
11.40%
6.70%
3.90%
5.30%
2004
8.28%
6.50%
6.10%
6.30%
2005
7.72%
3.70%
4.40%
4.05%
Asset Turnover
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
0.52
1.75
1.65
1.70
2002
0.52
1.28
1.78
1.53
2003
0.51
1.21
1.32
1.27
2004
0.54
1.31
1.02
1.17
2005
0.59
1.34
1.14
1.24
ROA
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
3.37%
22.30%
3.90%
13.10%
2002
5.94%
7.30%
5.10%
6.20%
2003
5.86%
8.10%
5.10%
6.60%
2004
4.45%
8.50%
6.20%
7.35%
2005
4.57%
5.00%
5.00%
5.00%
ROE
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
8.02%
202.00%
16.00%
109.00%
2002
13.14%
58.00%
18.20%
38.10%
2003
12.18%
59.50%
16.80%
38.15%
2004
8.91%
43.10%
18.20%
30.65%
2005
8.89%
24.50%
13.20%
19.00%
Debt to Equity Ratio
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
1.38
8.06
3.14
5.60
2002
1.21
6.89
2.60
4.75
2003
1.08
6.35
2.26
4.31
2004
1.00
4.05
1.94
3.00
2005
0.95
3.91
1.63
2.77
Times Interest Earned
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
3.40
5.90
3.61
4.76
2002
7.22
5.16
4.16
4.66
2003
8.81
6.05
5.48
5.77
2004
6.92
6.10
5.03
5.57
2005
7.47
4.99
4.30
4.65
- 50 -
Debt Service Margin
Kraft Foods Inc.
Sara Lee
ConAgra Foods
Industry
2001
1.75
3.12
1.01
2.07
2002
1.92
2.41
11.24
6.83
- 51 -
2003
2.05
1.82
1.40
1.61
2004
1.82
1.91
1.96
1.94
2005
1.53
3.54
9.45
6.54
Appendix B.
Forecasted Financials
Forecasted Balance Sheet
(Millions)
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
354
3503
396
3626
444
3753
497
3884
557
4020
624
4161
699
4307
782
4457
876
4613
981 Assume 12% growth rate
4775 Assume 3.5% growth rate
3343
3344
3344
3344
3345
3345
3345
3346
3346
3346 Assume .01% growth
8561
8989
9438
9910
10406
10926
11472
12046
12648
13280 Assume 5% growth rate
ASSETS
Cash and cash equivalents
Receivables (less allowances of $92 in
2005 and $118 in 2004)
Inventories:
Raw materials
Finished product
162
3131
215
3116
514
3369
282
3541
316
3385
1281
1745
1372
2010
1375
1968
1367
2080
1363
1980
Total Inventories
Deferred income taxes
Assets of discontinued operations held for sale
3026
466
3382
511
3343
681
3447
749
1458
3343
879
221
232
217
245
230
7006
7456
8124
9722
8153
387
2915
9264
706
387
3153
10108
802
407
3422
11293
683
400
3545
11892
646
388
3551
12008
651
13272
4163
14450
4891
15805
5650
16483
6498
16598
6781
9109
35957*
2675
1051
9559
24911
11509
2814
851
10155
25402
11477
3243
884
9985
25177
10634
3569
841
9817
24648
10516
3617
877
55798
57100
59285
59928
57628
61086
64751
68636
72754
77119
81746
86651
91850
97361
103203 Assume 6% growth rate
681
540
1652
1897
220
352
895
1939
553
775
543
2005
1818
750
227
2207
805
1268
652
2270
2338
2408
2480
2555
2632
2710
2792
2876
2962
3051 Assume 3% growth rate
1398
658
1821
228
1474
610
1316
363
1500
699
1335
451
1637
732
1537
170
1529
625
1338
237
8875
8134
5031
1850
5000
3430
7169
10416
5428
1889
2560
3806
7861
11591
5856
1894
9078
9723
6468
1887
8724
8475
6067
1931
9073
9436
9813
10206
10614
11039
11480
11939
12417
12914 Assume 4% growth rate'
3553
2861
2838
32320
31268
30755
30017
28035
29297
30615
31993
33432
34937
36509
38152
39869
41663
43537 Assume 4.5% growth rate
23655
2391
-2568
23655
4814
-2467
23704
7020
-1792
23762
8304
-1205
23835
9453
-1663
23478
26002
-170
28932
-402
30861
-950
31625
-2032
Total shareholders' equity
23478
25832
28530
29911
29593
31073
32626
34258
35970
37769
39657
41640
43722
45908
48204 Assume 5% growth rate
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
55798
57100
59285
59928
57628
31073
32626
34258
35970
37769
39657
41640
43722
45908
48204
Other current assets
Total current assets
Property, plant and equipment, at cost:
Land and land improvements
Buildings and building equipment
Machinery and equipment
Construction in progress
Less accumulated depreciation
Goodwill
Other intangible assets, net
Prepaid pension assets
Other assets
TOTAL ASSETS
LIABILITIES
Short-term borrowings
Current portion of long-term debt
Due to Altria Group, Inc. and affiliates
Accounts payable
Accrued liabilities:
Marketing
Employment costs
Other
Income taxes
Total current liabilities
Long-term debt
Deferred income taxes
Accrued postretirement health care costs
Notes payable to Altria Group, Inc. and afiliates
Other liabilities
Total liabilities
Contingencies (Note 18)
SHAREHOLDERS' EQUITY
Class A common stock, no par value (555,000,000
shares issued in 2005 and 2004)
Class B common stock, no par value (1,180,000,000
shares issued and outstanding in 2005 and
2004.00
Additional paid-in capital
Earnings reinvested in the business
Accumulated other comprehensive losses
(including currency translation of $(1,290)
in 2005 and $(890) in 2004)
Less cost of repurchased stock (65,119,245
Class A shares in 2005 and 29,644,926 Class
A shares in 2004)
Book Value Per Shares
13.53199 14.92317 16.56794 17.54311 17.72036
Shares Outstanding
1735
1731
1722
1705
1670
Current Market Value
34.03
38.93
32.22
35.61
28.17
- 52 -
Common Sized Balance Sheet
2001
(Millions)
ASSETS
Cash and cash equivalents
Receivables (less allowances of $92 in
2005 and $118 in 2004)
Inventories:
Raw materials
Finished product
Deferred income taxes
Assets of discontinued operations held
for sale
Other current assets
Total current assets
Property, plant and equipment, at cost:
Land and land improvements
Buildings and building equipment
Machinery and equipment
Construction in progress
Less accumulated depreciation
Goodwill
Other intangible assets, net
Prepaid pension assets
Other assets
2002
2003
2004
2005
0.29%
5.61%
0.38%
5.46%
0.87%
5.68%
0.47%
5.91%
0.55%
5.87%
2.30%
3.13%
2.40%
3.52%
2.32%
3.32%
2.28%
3.47%
2.37%
3.44%
5.42%
0.84%
5.92%
0.89%
5.64%
1.15%
5.75%
1.25%
2.43%
5.80%
1.53%
0.40%
0.41%
0.37%
0.41%
0.40%
12.56%
13.06%
13.70%
16.22%
14.15%
0.69%
5.22%
16.60%
1.27%
0.68%
5.52%
17.70%
1.40%
0.69%
5.77%
19.05%
1.15%
0.67%
5.92%
19.84%
1.08%
0.67%
6.16%
20.84%
1.13%
23.79%
7.46%
25.31%
8.57%
26.66%
9.53%
27.50%
10.84%
28.80%
11.77%
16.32%
16.74%
43.63%
20.16%
4.93%
1.49%
17.13%
42.85%
19.36%
5.47%
1.49%
16.66%
42.01%
17.74%
5.96%
1.40%
17.04%
42.77%
18.25%
6.28%
1.52%
0.00%
4.79%
1.88%
100.00% 100.00% 100.00% 100.00% 100.00%
TOTAL ASSETS
LIABILITIES
Short-term borrowings
Current portion of long-term debt
Due to Altria Group, Inc. and affiliates
Accounts payable
Accrued liabilities:
Marketing
Employment costs
Other
Income taxes
Total current liabilities
Long-term debt
Deferred income taxes
Accrued postretirement health care costs
Notes payable to Altria Group, Inc. and afiliates
Other liabilities
Total liabilities
Contingencies (Note 18)
SHAREHOLDERS' EQUITY
Class A common stock, no par value (555,000,000
shares issued in 2005 and 2004)
Class B common stock, no par value (1,180,000,000
shares issued and outstanding in 2005 and
2004.00
Additional paid-in capital
Earnings reinvested in the business
Accumulated other comprehensive losses
(including currency translation of $(1,290)
in 2005 and $(890) in 2004)
Less cost of repurchased stock (65,119,245
Class A shares in 2005 and 29,644,926 Class
A shares in 2004)
Total shareholders' equity
1.22%
0.97%
2.96%
3.40%
0.39%
0.62%
1.57%
3.40%
0.93%
1.31%
0.92%
3.38%
3.03%
1.25%
0.38%
3.68%
1.40%
2.20%
1.13%
3.94%
2.51%
1.18%
3.26%
0.41%
2.58%
1.07%
2.30%
0.64%
2.53%
1.18%
2.25%
0.76%
2.73%
1.22%
2.56%
0.28%
2.65%
1.08%
2.32%
0.41%
15.91%
14.58%
9.02%
3.32%
8.96%
6.15%
12.56%
18.24%
9.51%
3.31%
4.48%
6.67%
13.26%
19.55%
9.88%
3.19%
15.15%
16.22%
10.79%
3.15%
15.14%
14.71%
10.53%
3.35%
5.99%
4.77%
4.92%
57.92%
54.76%
51.88%
50.09%
48.65%
42.39%
4.29%
-4.60%
41.43%
8.43%
-4.32%
39.98%
11.84%
-3.02%
39.65%
13.86%
-2.01%
41.36%
16.40%
-2.89%
42.08%
0.00%
45.54%
-0.30%
48.80%
-0.68%
51.50%
-1.59%
54.88%
-3.53%
42.08%
45.24%
48.12%
49.91%
51.35%
100.00% 100.00% 100.00% 100.00% 100.00%
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
- 53 -
Forecasted Income Statement
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Net revenues
Cost of sales
(Millions)
29,234
17,566
29,723
17,720
30,498
18,531
32,168
20,281
34,113
21,845
35,478
36,897
38,372
39,907
41,504
43,164
44,890
46,686
48,553
50,496 Assume a 4% growth rate
21,948
22,826
23,739
24,689
25,677
26,704
27,772
28,883
30,038
31,239 Grew at Average of Gross Profit Margin
Gross profit
Marketing, administration and research
costs
Intergration costs and a loss on a sale of a food plant
Separtation programs
Asset impairment and exit costs
(Gains) losses on sales of businesses,
net
Amortization of intangibles
11,668
5,748
12,003
5,709
11,967
6,123
11,887
6,658
12,268
7,135
13,529
14,070
14,633
15,218
15,827
16,460
17,119
17,803
18,516
19,256
82
111
142
(8)
962
962
(80)
7
7
6
(31)
603
3
479
(108)
9
11
10
Operating income
Interest and other debt expense, net
4,884
1,437
6,114
847
5,860
665
4,612
666
4,752
636
4,895
5,041
5,193
5,348
5,509
5,674
5,844
6,020
6,200
639
642
646
649
652
655
659
662
665
Earnings from continuing operations before
income taxes and minority interest
Provision for income taxes
3,447
5,267
5,195
3,946
4,116
1,565
1,869
1,812
1,274
1,209
Earnings from continuing operations before
minority interest
Minority interest in earnings from continuing
operations, net
1,882
3,398
3,383
2,672
2,907
4
4
3
3
3,379
97
2,669
(4)
2,904
(272)
3,394
3,476
2,665
2,632
2,599
2,625
2,652
2,678
2,705
2,732
2,759
2,787
2,815
1.90
0.06
1.95
0.06
1.56
1.72
(0.16)
1.96
2.01
1.56
1.56
1.58
1.59
1.61
1.62
1.64
1.66
1.67
1.69
1.71
1.72 Assume 1% growth rate
1.90
0.06
1.95
0.06
1.55
1.72
(0.17)
1.96
2.01
1.55
1.55
1.57
1.58
1.60
1.61
1.63
1.65
1.66
1.68
1.70
1.71 Assume a 1% growth rate
Earnings from continuing operations
(Loss) earnings from discontinued operations,
net of income taxes
Net earnings
1,882
Per share data:
Basic earnings per share:
Continuing operations
Discontinued operations
Net earnings
1.17
Diluted earnings per share:
Continuing operations
Discontinued operations
Net earnings
1.17
- 54 -
2015
6,386 Assume 3% growth rate
669 Assume .05% growth rate
2,843 Assume 1% growth after 2006
Common Sized Income Statement
(Miilions)
2001
2002
100.000% 100.000%
60.088% 59.617%
Net revenues
Cost of sales
2003
2004
2005
100.000% 100.000% 100.000%
60.761% 63.047% 64.037%
Gross profit
Marketing, administration and research
costs
Intergration costs and a loss on a sale of a food plant
Separtation programs
Asset impairment and exit costs
(Gains) losses on sales of businesses,
net
Amortization of intangibles
39.912%
19.662%
40.383%
19.207%
39.239%
20.077%
36.953%
20.698%
35.963%
20.916%
0.280%
0.000%
0.000%
-0.027%
3.291%
3.291%
0.373%
0.478%
0.000%
-0.269%
0.024%
0.024%
0.000%
0.000%
0.020%
-0.102%
0.000%
0.030%
0.000%
0.000%
1.875%
0.009%
0.000%
0.034%
0.000%
0.000%
1.404%
-0.317%
0.000%
0.029%
Operating income
Interest and other debt expense, net
16.707%
4.916%
20.570%
2.850%
19.214%
2.180%
14.337%
2.070%
13.930%
1.864%
Earnings from continuing operations before
income taxes and minority interest
Provision for income taxes
11.791%
17.720%
17.034%
12.267%
12.066%
5.353%
6.288%
5.941%
3.960%
3.544%
Earnings from continuing operations before
minority interest
Minority interest in earnings from continuing
operations, net
6.438%
11.432%
11.093%
8.306%
8.522%
0.000%
0.013%
0.013%
0.009%
0.009%
Earnings from continuing operations
(Loss) earnings from discontinued operations,
net of income taxes
0.000%
0.000%
0.000%
0.000%
11.079%
0.318%
8.297%
-0.012%
8.513%
-0.797%
6.438%
11.419%
11.397%
8.285%
7.716%
0.000%
0.006%
0.006%
0.005%
0.005%
0.004%
0.007%
0.007%
0.005%
0.005%
0.000%
0.006%
0.006%
0.005%
0.005%
0.004%
0.007%
0.007%
0.005%
0.005%
Net earnings
Per share data:
Basic earnings per share:
Continuing operations
Discontinued operations
Net earnings
Diluted earnings per share:
Continuing operations
Discontinued operations
Net earnings
- 55 -
Forecasted Statement of Cash Flows
(Millions)
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings
Adjustments to reconcile net earnings
to operating cash flows:
Depreciation and amortization
Deferred income tax (benefit) provision
(Gains) losses on sales of businesses,
net
Integration costs, net of cash paid
Seperating Programs
Loss on sale of discontinued operations
Impairment loss on discontinued operations
Asset impairment and exit costs, net of
cash paid
Cash effects of changes, net of the effects
from acquired and
divested companies:
Receivables, net
Inventories
Accounts payable
Income taxes
Amounts due to Altria Group, Inc. and affiliates
Other working capital items
Change in pension assets and postretirement
liabilities, net
Other
Net cash provided by operating activities
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Capital expenditures
Purchases of businesses, net of acquired cash
Proceeds from sales of businesses
Other
Net cash provided by (used in) investing
activities
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Net (repayment) issuance of short-term
borrowings
Long-term debt proceeds
Long-term debt repaid
Repayment of notes payable to Altria Group,
Inc. and affiliates
Net Proceeds from sale of Class A Common Stock
Increase (decrease) in amounts due to Altria
Group, Inc. and affiliates
Repurchase of Class A common stock
Dividends paid
Other
Net cash used in financing activities
Effect of exchange rate changes on cash
and cash equivalents
Cash and cash equivalents:
Increase (decrease)
Balance at beginning of year
Balance at end of year
2001
2002
2003
2004
2005
2006
1,882
3,394
3,476
2,665
2,632
1,642
414
(8)
716
278
(80)
813
244
(31)
879
41
3
879
(408)
(108)
82
111
142
(26)
(1)
(1)
6
107
493
315
(45)
197
(116)
(125)
169
(167)
(419)
23
(65)
152
(251)
74
90
(436)
65
(42)
74
(33)
273
(432)
(10)
2007
2008
2009
2010
2011
2012
2013
2014
2015
32
23
(107)
(73)
74
138
(407)
(245)
116
(220)
(116)
277
(244)
(552)
(34)
(87)
(68)
143
234
228
3,328
3,720
4,119
4,008
3,464
(1,101)
(194)
21
52
(1,184)
(122)
219
35
(1,085)
(98)
96
38
(1,006)
(137)
18
69
(1,171)
(1,222)
(1,052)
(1,049)
(1,056)
525
2,505
(1,036)
819
(635)
(1,005)
4,077
(705)
(16,350)
3,325
(609)
(3,850)
1,577
(491)
(2,757)
832
(842)
69
(775)
8,425
142
660
(525)
(585)
107
(225)
(170)
(936)
(372)
(1,089)
52
(688)
(1,280)
(20)
(1,175)
(1,437)
265
(2,131)
(2,616)
(2,786)
(3,218)
(3,951)
(4)
1
15
34
(4)
(29)
191
53
162
299
215
(232)
514
34
282
162
215
514
282
316
3,498.64
3,603.60
3,711.71
3,823.06
3,937.75
4,055.88
4,177.56
4,302.89
4,431.97
4,564.93
Assume 1% growth rate
(1057.06)
(1058.11)
(1058.11)
(1059.17)
(1059.17)
(1060.23)
(1060.23)
(1061.29)
(1061.29)
(1062.35)
Assume .1% growth rate
1,668
28
Cash paid:
Interest
1,433
825
642
633
679
Income taxes
1,058
1,368
1,726
1,610
1,957
- 56 -
Financial Ratios
Liquidity Analysis
Current Ratio
Quick Asset Ratio
2001
2002
2003
2004
2005
2006
2007
0.95
0.43
2008
0.96
0.43
2009
0.97
0.43
2010
0.98
0.43
2011
0.99
0.43
2012
2013
2014
2015
0.79
0.37
1.04
0.46
1.03
0.49
1.07
0.42
0.93
0.42
0.94
0.43
1.00
0.44
1.01
0.44
1.02
0.44
1.03
0.45
9.34
39.09
5.81
62.88
-15.64
9.54
38.26
5.24
69.66
103.56
9.05
40.32
5.54
65.85
115.96
9.08
40.18
5.88
62.04
49.95
10.08
36.22
6.53
55.86
-59.74
10.13
36.04
6.56
55.60
-69.25
10.18
10.22
10.27
10.32
10.37
10.42
35.87
35.70
35.53
35.36
35.19
35.02
6.83
7.10
7.38
7.68
7.98
8.30
53.47
51.41
49.44
47.55
45.72
43.97
-82.51 -102.27 -134.90 -199.00 -382.51 -5542.64
10.47
34.85
8.63
42.28
439.20
10.52
34.68
8.98
40.66
210.18
10.58
34.51
9.34
39.10
137.69
39.91%
4.92%
6.44%
16.71%
0.52
3.37%
8.02%
40.38%
2.85%
11.42%
20.57%
0.52
5.94%
13.14%
1.38
3.40
1.75
1.21
7.22
1.92
1.08
8.81
2.05
1.00
6.92
1.82
0.95
7.47
1.53
0.94
7.66
1.50
0.94
7.85
1.50
0.93
8.04
1.50
0.93
8.24
1.50
0.93
8.45
1.50
0.92
8.66
1.50
0.92
8.87
1.50
0.91
9.09
1.50
0.91
9.32
1.50
0.90
9.55
1.50
15.41
23.68
15.33
23.81
15.21
24.00
14.58
25.04
15.03
24.29
15.17
24.05
15.32
23.82
15.47
23.59
15.62
23.37
15.77
23.14
15.92
22.92
16.08
22.70
16.24
22.48
16.39
22.27
16.55
22.05
0.06
0.15
0.10
0.21
0.08
0.17
0.05
0.09
0.04
0.08
0.03
0.07
0.03
0.06
0.02
0.04
0.02
0.03
0.01
0.02
0.01
0.01
0.00
0.00
-0.01
-0.01
-0.01
-0.02
-0.02
-0.03
Efficiency Analysis
Accounts Receivable Turnover
Days Sales Outstanding
Inventory Turnover
Days' Inventory
Working Capital Turnover
Profitability Analysis
Gross Profit Margin
Operating Expense Ratio
Net Profit Margin
Operating Profit Margin
Asset Turnover
Return on Assets
Return on Equity
39.24% 36.95% 35.96% 38.13% 38.13% 38.13% 38.13% 38.13% 38.13%
2.18% 2.07% 1.86% 1.80% 1.74% 1.68% 1.63% 1.57% 1.52%
11.40% 8.28% 7.72% 7.33% 7.12% 6.91% 6.71% 6.52% 6.33%
19.21% 14.34% 13.93% 13.80% 13.66% 13.53% 13.40% 13.27% 13.15%
0.51
0.54
0.59
0.58
0.57
0.56
0.55
0.54
0.53
5.86% 4.45% 4.57% 4.26% 4.05% 3.86% 3.68% 3.51% 3.34%
12.18% 8.91% 8.89% 8.37% 8.05% 7.74% 7.45% 7.16% 6.89%
38.13% 38.13% 38.13% 38.13%
1.47% 1.42% 1.37% 1.32%
6.15% 5.97% 5.80% 5.63%
13.02% 12.89% 12.77% 12.65%
0.52
0.51
0.50
0.49
3.18% 3.03% 2.89% 2.75%
6.63% 6.37% 6.13% 5.90%
Capital Structure Analysis
Debt to Equity Ratio
Times Interest Earned
Debt Service Margin
Other Ratios
Accounts Payable Turnover
Days' Payable
IGR= ROE*(1-dividend payout ratio)
SGR= IGR(1+(d/e))
- 57 -
Appendix C.
Cost of Capital
Cost of Equity: Ke
20 Year Regression
SUMMARY OUTPUT
60 months
Regression Statistics
Multiple R
0.330308084
R Square
0.10910343
Adjusted R Square
0.093194563
Standard Error
0.055283247
Observations
58
Rf
MRP
Beta
60
48
36
24
0.53055
0.69809
0.59747
0.50647
Upper 95%
Lower 95.0%
0.019923028 -0.009167542
0.936389029
0.124704541
Upper 95.0%
0.019923028
0.936389029
ANOVA
df
Regression
Residual
Total
Intercept
0.027391362
1
56
57
SS
MS
F
Significance F
0.020959756 0.0209598 6.8580263 0.01133158
0.171149292 0.0030562
0.192109048
Coefficients
Standard Error
t Stat
P-value
Lower 95%
0.005377743
0.007260877 0.7406465 0.4620021 -0.0091675
0.530546785
0.20259285 2.6187834 0.0113316 0.12470454
- 58 -
Adjusted R^2
0.09319
0.08773
0.07036
0.02803
0.0469
0.043
Ke
0.069714
0.076918
0.072591
0.068678
20 Year Data
Close
Dividends Firms Returns
34.36
-0.0012
34.4
-0.0353
35.66
0.25
0.0590
33.91
0.0466
32.4
0.0485
30.9
0.23
-0.0595
33.1
0.0595
31.24
0.0307
30.31
0.23
0.0150
30.09
0.0221
29.44
0.0451
28.17
0.23
0.0004
28.39
0.0032
28.3
-0.0749
30.59
0.23
-0.0058
31
0.0147
30.55
-0.0396
31.81
0.205
-0.0131
32.44
0.0009
32.41
-0.0194
33.05
0.205
-0.0058
33.45
-0.0156
33.98
-0.0458
35.61
0.205
0.0472
34.2
0.0267
33.31
0.0501
31.72
0.205
0.0206
31.28
0.0239
30.55
-0.0357
31.68
0.18
0.0670
29.86
-0.0927
32.91
0.0281
32.01
0.18
-0.0474
33.79
0.0491
32.21
-0.0003
32.22
0.18
0.0231
31.67
0.0883
29.1
-0.0136
29.5
0.18
-0.0007
29.7
0.0680
27.81
-0.1456
32.55
0.15
0.0093
32.4
0.0485
30.9
0.0957
28.2
0.15
-0.0426
29.61
-0.0703
31.85
-0.1819
38.93
0.15
0.0405
37.56
-0.0491
39.5
0.0834
36.46
0.15
-0.0795
39.77
0.0749
37
-0.0965
40.95
0.13
-0.0449
43.01
0.0480
41.04
0.0618
38.65
0.13
-0.0082
39.1
0.0550
37.06
0.0890
34.03
0.13
0.0314
33.12
33.75
34.37
32.25
30.95
31
Date
Close
Market Returns
1-Nov-06 1367.81
-0.0074
2-Oct-06 1377.94
0.0315
1-Sep-06 1335.85
0.0246
1-Aug-06 1303.82
0.0213
3-Jul-06 1276.66
0.0051
1-Jun-06
1270.2
0.0001
1-May-06 1270.09
-0.0309
3-Apr-06 1310.61
0.0122
1-Mar-06 1294.87
0.0111
1-Feb-06 1280.66
0.0005
3-Jan-06 1280.08
0.0255
1-Dec-05 1248.29
-0.0010
1-Nov-05 1249.48
0.0352
3-Oct-05 1207.01
-0.0177
1-Sep-05 1228.81
0.0069
1-Aug-05 1220.33
-0.0112
1-Jul-05 1234.18
0.0360
1-Jun-05 1191.33
-0.0001
2-May-05
1191.5
0.0300
1-Apr-05 1156.85
-0.0201
1-Mar-05 1180.59
-0.0191
1-Feb-05
1203.6
0.0189
3-Jan-05 1181.27
-0.0253
1-Dec-04 1211.92
0.0325
1-Nov-04 1173.82
0.0386
1-Oct-04
1130.2
0.0140
1-Sep-04 1114.58
0.0094
2-Aug-04 1104.24
0.0023
1-Jul-04 1101.72
-0.0343
1-Jun-04 1140.84
0.0180
3-May-04 1120.68
0.0121
1-Apr-04
1107.3
-0.0168
1-Mar-04 1126.21
-0.0164
2-Feb-04 1144.94
0.0122
2-Jan-04 1131.13
0.0173
1-Dec-03 1111.92
0.0508
3-Nov-03
1058.2
0.0071
1-Oct-03 1050.71
0.0550
2-Sep-03
995.97
-0.0119
1-Aug-03 1008.01
0.0179
1-Jul-03
990.31
0.0162
2-Jun-03
974.5
0.0113
1-May-03
963.59
0.0509
1-Apr-03
916.92
0.0810
3-Mar-03
848.18
0.0084
3-Feb-03
841.15
-0.0170
2-Jan-03
855.7
-0.0274
2-Dec-02
879.82
-0.0603
1-Nov-02
936.31
0.0571
1-Oct-02
885.76
0.0864
3-Sep-02
815.28
-0.1100
1-Aug-02
916.07
0.0049
1-Jul-02
911.62
-0.0790
3-Jun-02
989.82
-0.0725
1-May-02 1067.14
-0.0091
1-Apr-02 1076.92
-0.0614
1-Mar-02 1147.39
0.0367
1-Feb-02 1106.73
-0.0208
2-Jan-02
1130.2
-0.0156
3-Dec-01 1148.08
0.0076
1-Nov-01 1139.45
0.0752
1-Oct-01 1059.78
0.0181
4-Sep-01 1040.94
-0.0817
1-Aug-01 1133.58
-0.0641
2-Jul-01 1211.23
-0.0107
1-Jun-01 1224.38
-0.0250
1-May-01 1255.82
2-Apr-01 1249.46
1-Mar-01 1160.33
1-Feb-01 1239.94
2-Jan-01 1366.01
- 59 -
Date
2006-10-01
2006-09-01
2006-08-01
2006-07-01
2006-06-01
2006-05-01
2006-04-01
2006-03-01
2006-02-01
2006-01-01
2005-12-01
2005-11-01
2005-10-01
2005-09-01
2005-08-01
2005-07-01
2005-06-01
2005-05-01
2005-04-01
2005-03-01
2005-02-01
2005-01-01
2004-12-01
2004-11-01
2004-10-01
2004-09-01
2004-08-01
2004-07-01
2004-06-01
2004-05-01
2004-04-01
2004-03-01
2004-02-01
2004-01-01
2003-12-01
2003-11-01
2003-10-01
2003-09-01
2003-08-01
2003-07-01
2003-06-01
2003-05-01
2003-04-01
2003-03-01
2003-02-01
2003-01-01
2002-12-01
2002-11-01
2002-10-01
2002-09-01
2002-08-01
2002-07-01
2002-06-01
2002-05-01
2002-04-01
2002-03-01
2002-02-01
2002-01-01
2001-12-01
2001-11-01
2001-10-01
2001-09-01
2001-08-01
2001-07-01
2001-06-01
2001-05-01
2001-04-01
2001-03-01
2001-02-01
2001-01-01
Values
4.94
4.93
5.08
5.25
5.29
5.35
5.22
4.91
4.73
4.65
4.73
4.83
4.74
4.51
4.53
4.48
4.35
4.56
4.75
4.89
4.61
4.77
4.88
4.89
4.85
4.89
5.07
5.24
5.45
5.46
5.16
4.72
4.94
5.01
5.11
5.17
5.21
5.21
5.39
4.92
4.34
4.52
4.91
4.82
4.87
5.02
5.01
5.04
5.00
4.87
5.19
5.51
5.65
5.81
5.85
5.93
5.61
5.69
5.76
5.33
5.34
5.53
5.58
5.75
5.82
5.92
5.78
5.49
5.62
5.65
20 Year Rates
0.0041167
0.0041083
0.0042333
0.0043750
0.0044083
0.0044583
0.0043500
0.0040917
0.0039417
0.0038750
0.0039417
0.0040250
0.0039500
0.0037583
0.0037750
0.0037333
0.0036250
0.0038000
0.0039583
0.0040750
0.0038417
0.0039750
0.0040667
0.0040750
0.0040417
0.0040750
0.0042250
0.0043667
0.0045417
0.0045500
0.0043000
0.0039333
0.0041167
0.0041750
0.0042583
0.0043083
0.0043417
0.0043417
0.0044917
0.0041000
0.0036167
0.0037667
0.0040917
0.0040167
0.0040583
0.0041833
0.0041750
0.0042000
0.0041667
0.0040583
0.0043250
0.0045917
0.0047083
0.0048417
0.0048750
0.0049417
0.0046750
0.0047417
0.0048000
0.0044417
0.0044500
0.0046083
0.0046500
0.0047917
0.0048500
0.0049333
0.0048167
0.0045750
0.0046833
0.0047083
Market Premium
0.0273914
0.0204579
0.0170409
0.0007108
-0.0043217
-0.0353752
0.0078057
0.0070042
-0.0034886
0.0215918
-0.0048941
0.0311611
-0.0216907
0.0031906
-0.0149970
0.0322349
-0.0037677
0.0261520
-0.0240669
-0.0231926
0.0150617
-0.0292654
0.0283915
0.0345199
0.0099726
0.0052889
-0.0019377
-0.0386572
0.0134474
0.0075334
-0.0210908
-0.0202923
0.0080924
0.0131014
0.0465071
0.0028202
0.0506198
-0.0162860
0.0133815
0.0121237
0.0077056
0.0471320
0.0769525
0.0043409
-0.0210620
-0.0315980
-0.0645076
0.0528696
0.0822822
-0.1140827
0.0005564
-0.0835959
-0.0771637
-0.0139231
-0.0662927
0.0317972
-0.0254412
-0.0203155
0.0027738
0.0707343
0.0136490
-0.0863317
-0.0687584
-0.0155318
-0.0298854
-0.0049333
-0.0048167
-0.0045750
-0.0046833
-0.0047083
Cost of Debt (Kd)
LIABILITIES
0.049 Short-term borrowings
0.049 Current portion of long-term debt
0.055 Due to Altria Group, Inc. and affiliates
0.055 Accounts payable
0.059 Accrued liabilities:
Marketing
Employment costs
Other
Income taxes
0.0549
0.065
0.085
0.055
0.082
Total current liabilities
Long-term debt
Deferred income taxes
Accrued postretirement health care costs
Notes payable to Altria Group, Inc. and afiliates
Other liabilities
Total liabilities
5 Year Avg % of Total Liabilites
849
0.028
786
0.026
579
0.019
2,105
0.070
220
352
895
1,939
553
775
543
2,005
1,818
750
227
2,207
805
1,268
652
2,270
1,398
658
1,821
228
1,474
610
1,316
363
1,500
699
1,335
451
1,637
732
1,537
170
1,529
625
1,338
237
1,535
667
1,382
305
0.051
0.022
0.046
0.010
0.003
0.001
0.003
0.001
8,875
8,134
5,031
1,850
5,000
3,430
7,169
10,416
5,428
1,889
2,560
3,806
7,861
11,591
5,856
1,894
9,078
9,723
6,468
1,887
8,724
8,475
6,067
1,931
3,553
2,861
2,838
8,208
10,051
5,955
1,900
2,560
3,265
0.273
0.335
0.198
0.063
0.085
0.109
0.018
0.013
0.005
0.005
0.009
32,320
31,268
30,755
30,017
28,035
30,019
1.000
Kd
Weighted Average Cost of Capital
Value of the Firm
Value of Equity (Ke)
Value of Debt (Kd)
WACC(BT)
WACC(AT)
2005
$57,628
$29,593
$28,035
0.068
0.057
WACC(BT)=(Ve/Vf)(Ke)+(Vd/Vf)(Kd)
WACC(AT)=(Ve/Vf)(Ke)+(Vd/Vf)(Kd)(1-T)
Tax rate
Weighted Avg
0.001
0.001
0.001
0.004
681
540
1,652
1,897
35%
- 60 -
0.065
Appendix D.
Valuations Models
Discounted Dividend Model
Kraft Foods Inc.
(Amounts in millions of dollars except per share data)
Years from valuation date
Dividends per share
Present Value Factor
2005
0.85
Present Value of Future Dividends
Total Present Value of Forecast Future Dividends
Continuing (Terminal) Value (assume no growth)
Present Value of Continuing (Terminal) Value
Estimated Value per Share 2005
Estimated Value per Share November 2006
Earnings Per Share
Dividends per share
Book Value Per Share
Actual Price per share
Cost of Equity
Growth Rate
1
2006
0.94
0.935
2
2007
1.03
0.874
3
2008
1.13
0.817
4
2009
1.24
0.764
5
2010
1.37
0.714
6
2011
1.51
0.667
7
2012
1.66
0.624
8
2013
1.82
0.583
9
2014
2.00
0.545
$0.87
$0.90
$0.92
$0.95
$0.98
$1.01
$1.03
$1.06
$1.09
10
Terminal
2015
2.20
2.20
0.510
$1.12
$9.94
$31.62
$16.12
$26.06
$27.72
$1.57
$0.94
$1.58
$1.03
$1.60
$1.13
$1.61
$1.24
$1.63
$1.37
$1.65
$1.51
$1.66
$1.66
$1.68
$1.82
$17.72
Sensitivity Analysis
$34.36
6.97%
0
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
g
0
0.01
0.03
$105.51 $197.60
N/A
$68.95
$97.04
N/A
$50.75
$63.62 $166.54
$39.89
$46.97
$82.35
$32.70
$37.03
$54.34
$27.60
$30.44
$40.37
$23.80
$25.76
$32.02
$20.87
$22.27
$26.47
- 61 -
0.05
N/A
N/A
N/A
N/A
$140.92
$70.19
$46.63
$34.87
0.07
N/A
N/A
N/A
N/A
N/A
N/A
$119.69
$60.07
0.09
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$1.70
$2.00
$1.71
$2.20
Discounted Free Cash Flows Model
(Amounts in millions of dollars except per share data)
Cash Flow from Operations
Cash Provided (Used) by Investing Activities
Free Cash Flow (to firm)
Discount Rate (6.77% WACC)
Present Value of Free Cash Flows
Total Present Value of Annual Cash Flows
Continuing (Terminal) Value (assume no growth)
Present Value of Continuing (Terminal) Value
Value of the Firm (end of 2005)
Book Value of Debt and Preferred Stock
Value of Equity (end of 2005)
Estimated Value per Share December 2005
Estimated Value per Share November 1 2006
Book Value per Share
Actual Price per share
WACC
Growth Rate
Shares Outstanding
2005
1
2
3
4
5
6
7
8
9
10
2015
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Terminal
3,498.64 3,603.60 3,711.71 3,823.06 3,937.75 4,055.88 4,177.56 4,302.89 4,431.97 4,564.93
(1,057.06) (1,058.11) (1,058.11) (1,059.17) (1,059.17) (1,060.23) (1,060.23) (1,061.29) (1,061.29) (1,062.35)
2,441.58 2,545.49 2,653.59 2,763.89 2,878.58 2,995.65 3,117.33 3,241.60 3,370.68 3,502.58 3,502.58
0.937
0.877
0.822
0.770
0.721
0.675
0.632
0.592
0.555
0.520
2286.85
2233.08
2180.39
2127.09
2074.97
2022.51
1971.28
1919.96
1869.89
1819.93
20,506
51766.56
26,898
47,404
$114.9
47,289
$28.32
$30.07
17.72
$34.36
6.77%
0.00%
1670
Sensitivity Analysis
WACC
0.020
0.025
0.030
0.035
0.040
0.045
0.050
0.055
0.060
0.065
0.070
- 62 -
0
$103.59
$82.66
$68.72
$58.77
$51.31
$45.52
$40.90
$37.12
$33.98
$31.32
$29.05
0.01
$191.20
$127.35
$95.44
$76.30
$63.55
$54.45
$47.63
$42.33
$38.09
$34.63
$31.75
g
0.02
N/A
$350.81
$175.62
$177.22
$88.03
$70.52
$58.85
$50.52
$44.27
$39.41
$35.53
0.03
N/A
N/A
N/A
$321.82
$161.47
$108.02
$81.29
$65.26
$54.57
$46.93
$41.20
0.04
N/A
N/A
N/A
N/A
N/A
$295.51
$148.62
$99.65
$75.16
$60.46
$50.65
0.05
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$271.60
$136.93
$92.02
$69.56
Residual Income Model
1
2006
$17.72
$1.57
$0.94
18.35
2
2007
$18.35
$1.58
$1.03
18.90
3
2008
$18.90
$1.60
$1.13
19.37
1.24
0.33
0.93
0.31
8.83%
8.446% Growth
1.28
0.30
0.87
0.26
8.62%
(0.02)
Avg:
1.32
0.28
0.82
0.23
8.45%
(0.02)
(0.002)
2005
Beginning BE (per share)
Earnings Per Share
Dividends per share
Ending BE (per share)
Ke
"Normal" Income
Residual Income (RI)
Discount Factor
Present Value of RI
ROE
Average ROE
BV Equity (per share) 2004
Total PV of RI (end 2004)
Continuation (Terminal) Value
PV of Terminal Value (end 2004)
Estimated Value (2005)
Estimated Value (November 2006)
Actual Price per share
Growth
$17.72
6.97%
$17.72
2.01
11.42601
5.8240
$25.55
$26.28
Residual Income Valuation
4
5
6
7
2009
2010
2011
2012
$19.37
$19.74
$20.00
$20.14
$1.61
$1.63
$1.65
$1.66
$1.24
$1.37
$1.51
$1.66
19.74
20.00
20.14
20.14
8
2013
$20.14
$1.68
$1.82
20.00
9
2014
$20.00
$1.70
$2.00
19.69
10 Terminal
2015
$19.69
$1.71
$2.20
19.20
1.35
0.26
0.76
0.20
8.33%
(0.01)
1.40
0.27
0.58
0.16
8.33%
0.01
1.39
0.30
0.55
0.16
8.48%
0.02
1.37
0.34
0.51
0.17
8.70%
0.03
1.38
0.25
0.71
0.18
8.25%
(0.01)
1.39
0.25
0.67
0.17
8.23%
(0.00)
1.40
0.26
0.62
0.16
8.25%
0.00
0.3395
Sensitivity Analysis
G
$34.36
0.04
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
0.11
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
$83.69
$55.20
$40.31
$32.45
$26.78
$22.74
$19.72
$17.38
$15.52
$13.99
$138.22
$69.28
$46.26
$34.73
$27.79
$23.16
$19.84
$17.35
$15.40
$13.84
N/A
$111.52
$56.84
$38.53
$29.31
$23.74
$20.00
$17.30
$15.26
$13.66
N/A
N/A
$88.59
$46.13
$31.84
$24.61
$20.21
$17.24
$15.07
$13.42
N/A
N/A
N/A
$68.92
$36.90
$26.07
$20.54
$17.15
$14.83
$13.13
N/A
N/A
N/A
N/A
$52.09
$28.98
$21.09
$17.02
$14.49
$12.73
$1.91
N/A
N/A
N/A
N/A
$37.71
$22.18
$16.80
$13.97
$12.17
$7.36
$5.92
$3.94
$0.54
N/A
N/A
$25.46
$16.36
$13.11
$11.34
$10.99
$10.14
$9.23
$8.14
$6.54
$2.79
N/A
$15.05
$11.39
$9.95
- 63 -
Residual Income Model Graph
Residual Income Futrure Growth Prediction
0.40
0.35
0.30
0.25
0.20
Residual Income
0.15
0.10
0.05
0.00
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
- 64 -
Long Run Residual Income Model
BV Equity per Share
Return on Equity
Ke
Growth Rate
Estimated Price per Share
17.72
8.446%
6.97%
0.04
26.52
Sensitivity Analysis
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
g
0
0.01
0.02
0.03
$74.84 $131.95
N/A
N/A
$49.89
$65.98 $114.23
N/A
$37.42
$43.98
$57.12 $96.51
$29.93
$32.99
$38.08
$48.26
$24.95
$26.39
$28.56
$32.17
$21.38
$21.99
$22.85
$24.13
$18.71
$18.85
$19.04
$19.30
$16.63
$16.49
$16.32
$16.09
$14.97
$14.66
$14.28
$13.79
- 65 -
0.04
N/A
N/A
N/A
$78.79
$39.40
$26.26
$19.70
$15.76
$13.13
0.05
N/A
N/A
N/A
N/A
$61.07
$30.54
$20.36
$15.27
$12.21
Abnormal Earnings Growth Model
-0.02830
1
2005
2006
1.57
0.94
EPS
DPS
DPS invested at 6.97%
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
PV Factor
PV of AEG
($0.02)
$1.30
$0.71
$0.69
$1.57
$2.25
0.0697135
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of AEG
Core EPS
Growth Adjust EPS Perp
Capitalization Rate (perpetuity)
Value Per Share 2005
Value Per Share 2006
Ke
G
Actual Price per share
$32.34
$33.26
6.97%
0.04
-0.02272
2
-0.01649
3
Forecast Years
2009
-0.00956
4
2010
-0.00184
5
2007
2008
1.58
1.03
0.065
1.65
1.67
(0.0283)
1.60
1.13
0.072
1.67
1.69
(0.0227)
1.61
1.24
0.079
1.69
1.71
(0.0165)
1.63
1.37
0.087
1.72
1.73
(0.009557)
2011
1.65
1.51
0.095
1.74
1.74
(0.001844)
0.935
($0.03)
0.874
($0.02)
0.817
($0.01)
0.764
($0.01)
0.714
($0.00)
0.00673
6
2012
1.66
1.66
0.105
1.77
1.76
0.006726
0.667
$0.00
0.01624
7
2013
1.68
1.82
0.115
1.79
1.78
0.016242
0.624
$0.01
0.02680
8
2014
0.03850
9
0.00000
Perp
2015
1.70
2.00
0.127
1.82
1.80
0.026797
0.583
$0.02
1.71
2.20
0.140
1.85
1.81
0.038497
0.0385
0.545
$0.02
Sensitivity Analysis
g
Ke
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
-0.08
$93.45
$61.36
$45.33
$35.73
$29.34
$24.80
$21.41
$18.78
$34.36
- 66 -
-0.06
$95.89
$62.73
$46.20
$36.33
$29.77
$25.12
$21.65
$18.96
-0.04
$99.96
$64.89
$47.51
$37.19
$30.37
$25.55
$21.97
$19.21
-0.02
$108.09
$68.76
$49.69
$38.54
$31.27
$26.17
$22.41
$19.54
0.01
0.01
0.01
0
0.02
N/A
$123.02
$67.14
$46.66
$35.75
$28.91
$24.21
$20.77
0.04
N/A
N/A
N/A
$75.08
$44.72
$33.02
$26.45
$22.13
0.01
0.01
-1
$132.49
$77.81
$54.05
$40.98
$32.76
$27.15
$23.09
$20.02
Abnormal Earnings Growth Graph
AEG Future Growth Prediction
0.0500
0.0400
0.0300
0.0200
0.0100
AEG
0.0000
2006
2007
2008
2009
2010
2011
(0.0100)
(0.0200)
(0.0300)
(0.0400)
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2012
2013
2014
2015
Appendix E.
EPS
Kraft
Sara Lee
ConAgra
EPS
Kraft
Sara Lee
ConAgra
Method of Comparables
2004
BPS
DPS
PPS
1.87
17.54
0.75
35.61
1.59
3.71
0.75
46.08
1.5
9.3
1.03
29.45
2005
BPS
DPS
PPS
1.88
17.72
0.85
28.21
1.36
3.74
0.78
36.95
1.35
9.38
1.07
20.28
Comparables (KFT) P/E Trailing P/E Forecast
Kraft's Price (2004)
$19.04
$39.44
Kraft's Price (2005)
$15.01
$39.20
Industry Avg. (2004)
24.31
21.09
Industry Avg. (2005)
21.09
20.85
P/B
$136.64
$106.67
7.79
6.02
D/P
$25.86
$22.97
0.029
0.037
P/S
$27.54
$22.68
1.46
1.11
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PEG
P/EBIT P/EBITDA
M/B
$20.09
$35.11
$84.37 $ 2.03
$19.86
$29.47
$71.59 $ 1.59
0.341
13.01
12.98
3.78
0.1475
10.34
10.36
3.07
Resources
1.
Kraft Foods Inc. 2001-2005 10K (www.kraft.com) (www.edgarscan.pwcglobal.com)
2.
Sara Lee 2001-2005 10K (www.saralee.com) (www.edgarscan.pwcglobal.com)
3.
ConAgra Foods Inc. 2001-2005 10K (www.edgarscan.pwcglobal.com)
4.
Kraft Value Line, November 3, 2006 (www.ttu.edu)
5.
Sara Lee Value Line, November 3, 2006 (www.fidelity.com)
6.
ConAgra Value Line, November 3, 2006 (www.fidelity.com)
7.
Kraft S&P 500 Report, October 3, 2006 (www.fidelity.com)
8.
Sara Lee S&P 500 Report, October 3, 2006
9.
ConAgra S&P 500 Report, October 3, 2006
10.
www.yahoo.finance.com
11.
www.wsj.com
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