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Morningstar | Mondelez Delivers Sales and Profits Gains, But Opts to Up Brand Spend in 2019; Shares Attractive

Closing the book on his first full year at the helm, Mondelez’s CEO Dirk Van de Put struck a conciliatory tone, calling out the progress made to date while emphasizing the need for further investments to ensure recent momentum persists. For the fourth quarter, organic sales popped 2.5% (generally in line with the 2.4% mark etched for the full year), with growth balanced between price (up 1.5%) as well as the combination of higher volumes and favorable mix (1%). We view this growth even more favorably given this performance came on top of 2% gains posted a year ago.

Despite Mondelez’s focus on reigniting the firm’s top-line performance, we don’t posit that it is abandoning its past strategic intent to extract efficiencies from its operations. In the quarter, adjusted gross margins popped 90 basis points to 40% even though the firm faced inflationary pressures surrounding raw materials and logistic costs, and adjusted operating margins improved 50 basis points to 16.2% as the firm opted to invest further behind marketing its brands, although management failed to quantity the extent).

And we don’t believe management intends to rest on its laurels, as its fiscal 2019 profit expectation (just 3%-5% adjusted EPS growth, first disclosed at its investor event in September) highlights its desire to up the ante on near-term brand spending to support long-term growth, which we view as prudent. We believe these efforts should support its entrenched retail relationships and its leading brand mix, and when combined with its expansive global scale should ensure its wide economic moat proves unwavering. In this vein, we don’t intend to alter our long-term forecast (3%-4% average annual top line growth and another 300 basis points of operating margin expansion above fiscal 2018 to around 20% by fiscal 2028) and are holding the line on our $52 fair value estimate. Trading at a 15% discount to our valuation, we’d suggest investors consider building a position in this name.

Mondelez’s emerging markets (just less than 40% of sales, with organic sales up 6.5% in the quarter) continue to outshine the firm’s developed markets (up just 0.2%). But as a means to ensure this growth proves sustainable (and comes alongside further share gains) while also elevating its trajectory in developed market regions, Mondelez is opting to employ a multifaceted approach, the facets of which we view as prudent.

For one, management is setting out to empower its local leaders to a greater extent. We view this as important, given tastes and preferences vary around the world, and we believe the inability to effectively tailor its mix could stand to impede sustained share and volume gains. In this vein, management is targeting mid-single-digit long-term sales growth in its emerging market regions versus low-single-digit growth in developed markets, both of which align with our forecast. Further, the firm continues to emphasize a desire to move away from large-scale product launches to more of a “test and learn” approach, centered on launching a product in a select local market, assessing the consumer response, and altering the offering as necessary to more effectively win with consumers around the world. We think this should position Mondelez to more nimbly respond to evolving consumer trends. We’ve long held that the product development timeline of established packaged food manufacturers has historically proved too onerous (with product innovation across the industry taking anywhere from 18 to 24 months to move from concept to shelf in the past), and we look favorably on efforts to combat these challenges.

But we don’t believe the firm’s focus for improvement is solely tied to boosting sales. However, while management has alluded to the potential for further efficiency gains between fiscal 2019 and fiscal 2022, it has been reluctant to quantify its aim. We posit an additional $1 billion in excess costs could be removed (on top of the $1.5 billion realized over the past several years), centered on removing complexity from its operations (including rationalizing its suppliers, parting ways with unprofitable brands, and continuing to upgrade its manufacturing facilities). But we don’t believe the entirety of these savings will drop to the bottom line; rather, we expect Mondelez will up investments behind its brands, supporting the intangible asset source of its wide moat. As such, we haven’t wavered on our forecast, which calls for research, development, and marketing to amount to about 8% of sales over the next 10 years (or about $2.6 billion annually).

We will be attending the Consumer Analyst Group of New York Conference in a few weeks, and we hope Van de Put takes the opportunity to expound upon the early read of its recent strategic efforts to reignite sales while driving further profit improvement. In addition, we will be looking to get a sense of Mondelez’s current appetite for deals and overall priorities for cash. We think that despite remaining on the sidelines for the better part of the last few years, the firm could return as a consolidator in the space. We believe the opportunity to expand its footprint into untapped markets--such as Indonesia and Germany--or expand into other adjacent snacking categories could be in the cards. But despite our suspicion that it could become a more active acquirer (with our estimates suggesting it could assume an additional $6 billion to $7 billion in long-term debt, which would take debt/adjusted
EBITDA from the mid-3s to the mid-4s), we don’t posit Mondelez will veer from its historic bent of operating as a prudent capital allocator—as shown in its adjusted returns on invested capital have exceeded our cost of capital estimate in each of the past five years.