Parnassus Digest - April 2013
Investment Thesis: Mondelez
A favorite investing book around the office is You Can Be A Stock Market Genius by Joel Greenblatt. In this book, Mr. Greenblatt discusses how spinoffs frequently unlock substantial value for shareholders. An attractive spinoff occurred during October 2012, when Kraft spun out its North American grocery business and renamed its global snacks business Mondelez. In this Parnassus Digest, Senior Research Analyst Robert Klaber shares what makes Mondelez a great example of a Parnassus investment.
We think Mondelez provides one of the best long-term growth stories in the consumer staples sector. Mondelez generates $35 billion in revenue and is dominant in the chocolate, cookies/crackers, candy, gum, and coffee categories. See Exhibit 1 for a breakdown of Mondelez’s sales by category. It has all the characteristics of what we’re looking for at Parnassus Investments: the company is a leader in an industry with secular tailwinds, possesses a sustainable competitive advantage, has quality management, trades at an attractive valuation, and has a strong environmental, social, and governance (ESG) profile. We believe the stock provides an asymmetric risk-reward profile that should enable outperformance in bull or bear markets.
Mondelez is a highly relevant company as it is the number one or two player in virtually every market in which it competes (see Exhibit 2). The company owns dozens of iconic brands, eight of which generate more than $1 billion in revenue: Cadbury, Milka, Oreo, Nabisco, Trident, Jacobs, Tang, and LU.
We think Mondelez should benefit from secular tailwinds in both developing and developed countries. According to Euromonitor data, more than 75% of the growth in global food sales during the next five years is expected to come from emerging markets. In our opinion, Mondelez is well-positioned because approximately 40% of its sales is generated from these markets. Income growth in these countries will continue to drive higher consumption across Mondelez’s products, as there is a strong correlation between GDP per capita and dollars spent on snacks per person. This is because consumers initially fill their basic food needs and, as they become wealthier, they start buying more impulse-driven categories. In developed countries, snacks continue to gain market share because they are consumed throughout the entire day, not just during traditional meal times like many other packaged food categories.
Importantly, the risk from private label competition is relatively low. On average, private label represents 18% of sales in the food and beverage industry. In all of Mondelez’s categories, private label competition is below this level. Many of Mondelez’s categories have extraordinarily low private label penetration, such as chewing gum at just over 0% and chocolate at 1%. Low private label competition helps Mondelez achieve best-in-class price elasticity, which means that consumers have continued to purchase Mondelez’s products even in the face of higher prices.
We believe the company has a sustainable competitive advantage for three reasons. First, Mondelez has the broadest distribution network across its main categories. The 2010 acquisition of Cadbury has been a boon in several ways, but perhaps most important is the fact that Cadbury provides a complimentary distribution network. Cadbury has expertise in instant consumption channels (e.g., convenience stores), whereas Mondelez has strong relationships in warehouse channels (e.g., Wal-Mart). Combining forces increased Mondelez’s outlet coverage by 58% in Mexico, 40% in Russia, 33% in China, and 25% in Brazil.
Second, as one of the largest food companies in the world, Mondelez has substantial economies of scale. What is unique about Mondelez is that the company has economies of scale in both developed and developing countries. The company’s operating margins in developing countries are actually higher than the firm’s overall average, which is rare among U.S.-based food companies. We believe that unlike most other American food companies, Mondelez has had a foothold in emerging markets for a long time. For example, Cadbury opened its first factory in India in 1949, and Mondelez entered China in 1984, making it one of the first U.S. companies to do so.
Third, Mondelez’s dominant brands afford it prime shelf space. Walk into any grocery or convenience store and you are sure to see many of their well-known brands such as Oreo, Chips Ahoy, Toblerone, Cadbury, or Ritz.
With regard to management, Mondelez is led by the former Kraft (ex-North American grocery) team, which is highly regarded for its industry expertise. The top seven executives have an average of 22 years of industry experience. Irene Rosenfeld became CEO in 2006, and she has done an excellent job reinvigorating iconic brands (e.g., Oreos) and increasing revenue from developing markets.
We were able to buy this high quality business at a discounted price after Mondelez missed revenue expectations for two consecutive quarters following the spinoff from Kraft. We purchased shares when the company traded at a double digit discount to its peers. Given the company’s faster revenue profile relative to peers, we think Mondelez should trade at a premium once it achieves its stated growth algorithm of 5-7%. This algorithm is reasonable since Mondelez can achieve 6% revenue growth simply by growing in-line with its categories. In other words, Mondelez only needs to match its categories’ growth rates to achieve 6% growth – it does not need to gain market share. Additionally, the company delivered 6% growth, on average, during the past six years.
Even though Mondelez sells snack foods, which can be unhealthy if consumed in excess, we think it has a positive overall ESG profile. The reason is that management is actively improving the healthiness of the company’s products. Mondelez has done a commendable job in this respect, as virtually all of the company’s products now come in reduced fat or reduced calorie versions. The company also developed 100-Calorie Packs, which enable easy-to-manage portion control. Additionally, Mondelez has been a leader in nutrition education for a long time. It was the first company to announce global principles for advertising to children, which now serve as a model for the industry. On top of that, the company provides nutrition labeling on all products in all markets worldwide, even where it is not required by law. Finally, we favor companies with great workplaces. Mondelez has been ranked by DiversityInc as the seventh Best Company for Diversity and named to Working Mother’s “100 Best Companies” list.1
I hope that this Parnassus Digest provided a deeper insight into what makes Mondelez a great example of a Parnassus investment.
We appreciate your investment with us.
Parnassus Workplace Fund Featured In Fast Company Magazine. Since its inception in 2005, the Parnassus Workplace Fund has invested in undervalued equity securities with outstanding workplaces. Recently, author Mark C. Crowley interviewed Portfolio Manager Jerome L. Dodson for an article in Fast Company Magazine called The Proof is in the Profits: America’s Happiest Companies Make More Money.
In his article, Crowley questions whether or not there is a direct connection between having happy workers and improved profitability and concludes, "Milton Moskowitz and Jerome Dodson have gone on to prove that the leaders at organizations which ensure employees feel valued, supported, developed, and rewarded are the most enlightened. They inspire a greatly expanded bottom line and set an example for all to follow in this 21st century."
The full article can be found at the following website:
Fast Company Magazine - The Proof is in the Profits: America’s Happiest Companies Make More Money
1Kraft Foods ranked 7 of 50 on the Best Companies for Diversity list in 2012 by DiversityInc. In 2012, Kraft Foods was included on the 2012 Working Mother 100 Best Companies List. At the time, Mondelez was still a part of Kraft Foods.
Percentage of Parnassus Funds represented by Mondelez Inc. as of March 31, 2013 is 0.5% of the Parnassus Fund, 2.7% of the Parnassus Workplace Fund, and 2.1% of the Parnassus Equity Income Fund.
The views expressed in this Parnassus Digest are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds. Any specific securities discussed may or may not be current or future holdings of the Funds.
The Parnassus Funds are underwritten and distributed by Parnassus Funds Distributor, a subsidiary of Parnassus Investments and a FINRA member.
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