Published 21 October 2009
By Owain Bennallack
For most active investors, Kraft's proposal to gobble up UK chocolate maker Cadbury (LSE:CBRY) has provided a new lease of life for the equity market rally, hinting at the return of the 'animal spirits' that drive bull markets higher.
For Cadbury's management, though, it's more a frustrating Curly Wurly conundrum than a Time Out moment.
Solid and defensive companies like Cadbury are ignored during bull markets. Yet just when management might enjoy the praise of their shareholders for steering their company through a deep recession, along come the yanks with their sticks of gum to buy new chums.
Enough confectionery metaphors. Having firmly rejected Kraft's offer on 31 August -- and with the Takeover Panel giving Kraft until 9 November to 'put up or shut up' -- Cadbury's board knows today's third-quarter results release is the best chance it has of rebuffing the US predator.
These quarterly numbers would have been positive even without Kraft looking over its shoulder; Cadbury is having a good recession. The question for investors is how sweet is the outlook?
"Beyond expectations"
"We have great momentum in our business and our confectionery strategy continues to yield benefits beyond expectations," said Todd Stitzer, Cadbury's CEO -- perhaps not fully grasping how greedily expectant investors can be.
Still, revenue growth of 7% year-on-year is no mean achievement, especially as that's on a constant currency basis rather than due to the weak dollar pick-me-up so many FTSE 100 companies have enjoyed. Analysts were expecting less than 5%.
Growth was particularly strong in the emerging markets, with sales in South America up 18%, and Asia, the Middle East and Africa up 14%. That's significant because it's these younger, faster-growing regions that are thought to have encouraged Kraft's attention.
There's more to come, too, said Stitzer, who raised Cadbury's revenue growth outlook to around "the middle of our 4-6% goal range for the year as a whole". (A fancy way of saying 5%, while avoiding being pinned down later).
Underlying operating margins are expected to improve by at least 1.35% on a constant currency basis from 11.9% in 2008, as Cadbury continues to implement its 'Vision into Action' strategy. In the world of mass-market chocolate making, implementing a vision means doing things like relocating Mini Egg making to Poland, and closing down factories at home.
"We have maintained our investments in innovation and marketing to reinforce our commitment to delivering future growth," said Stitzer. He didn't add "Please, please don't sell your Cadbury shares to Kraft".
Chairman Roger Carr was more direct: "The strength of our operating performance continues to underpin the Board's confidence in both our growth prospects and the potential for creating further, material shareholder value as a pure play standalone confectionery business".
Needless to say, Kraft -- which makes everything from salad dressings and Maxwell House coffee to Terry's Chocolate Oranges and 'Chicken in a Bizkit' -- is not "a pure play standalone confectionery business."
Too much to swallow
The financial press will now speculate as to whether Cadbury 'has done enough' to convince investors to stick with it.
The grubbier truth is it's all down to price. Cadbury is part of the UK corporate furniture, but neither investors nor the British government is going to back its management or block Kraft for sentimental reasons.
The question is whether Kraft will want to pay an even higher premium for Cadbury's shares than is already implied by the market.
Kraft's initial 745p offer valued the company at £10.2 billion and saw the shares boom 40%, from below £6 to around the £8 mark. Some analysts on the newswires this morning argue that any revised Kraft offer will have to be over £9 in light of today's results.
That could be optimistic. According to press reports, Kraft has already lined up its syndicate of lenders, while the New York Post reported last Friday that Kraft was in talks to sell its Maxwell House coffee brand to Sara Lee Corporation, presumably to bolster its financial muscle.
Kraft must have known its first offer would be rejected, and CEO Irene Rosenfield presumably has something extra in her pocket to try to tip the deal.
But with the most famous investor on her shareholder register, Warren Buffet, describing the Cadbury offer as a 'full price' already and suggesting Kraft's shares were themselves undervalued -- reducing the likelihood of any paper-based deal -- I think £9 is asking too much.
The next Cadbury
The market still seems to think around 800p should do it, as the shares have only firmed up around that price this morning, rather than racing away.
Kraft may have its reasons for pursuing Cadbury, but new investors would be risking a lot in chasing the price higher. Cadbury shares are on a historic P/E of 32, dropping to 22.5 on this year's forecasts of around 35.5p and 20 for 2010's estimates, for what they're worth. The forecast yield is a little over 2%.
Earnings will be tweaked up in light of the better sales and margins, but relatively slow-growth Cadbury is still headily related compared to the wider market.
The irony is everything that is true of Cadbury today was true the day before Kraft made its move. Investors hoping to squeeze a few more pence out from a takeover might be better off selling their shares and looking for the next great undervalued opportunity.
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