QUIC RESEARCH REPORT Consumers & Healthcare Julie Vincent Jon Allion Andrei Florescu Liam Smith Mondelez (NASDAQ: MDLZ) Stock Pitch A Stock as Sweet as it s Oreo Cookies Introduction Mondelez is the market leader in the snack food segment. With a strong brand portfolio that is well-positioned to capitalize on the sector s future growth, we believe that Mondelez will see significant upside in the years to come. By adding Mondelez to our U.S portfolio, we will be exposed to the lucrative snack foods segment and benefit from their strong financial position. Summary - Mondelez operates in the global snack industry, competing with names such as PepsiCo and Conagra Foods - Mondelez has a wide range of brand offerings, led by its seven power brands, each garnering over $1 billion in annual sales - The company has begun to focus its investments to emerging markets, which grow at fast rates while being driven by increasing consumer demand for snacks - The company s increased focus on effective capital deployment will increase margins and a result bolster company profitability - Recent e-commerce expansion and a stronger focus on healthy products serve as strong catalysts for the company QUIC Research Reports focus on emerging investment themes that affect current portfolio companies and companies under coverage. The information in this document is for EDUCATIONAL and NON-COMMERCIAL use only and is not intended to constitute specific legal, accounting, financial or tax advice for any individual. In no event will QUIC, its members or directors, or Queen s University be liable to you or anyone else for any loss or damages whatsoever (including direct, indirect, special, incidental, consequential, exemplary or punitive damages) resulting from the use of this document, or reliance on the information or content found within this document. The information may not be reproduced or republished in any part without the prior written consent of QUIC and Queen s University. QUIC is not in the business of advising or holding themselves out as being in the business of advising. Many factors may affect the applicability of any statement or comment that appear in our documents to an individual's particular circumstances. Queen s University 2016
Table of Contents Introduction 1 Company Overview 3 Industry Overview 4 Investment Thesis I: Strong Brand Profile 5 Investment Thesis II: Emerging Markets 6 Investment Thesis III: Margin Expansion 7 Catalysts and Risks 8 Portfolio Fit 8 Valuation 9 Appendix 11 References 12
Company Overview Mondelez s powerful presence in the snacking category is led by 7 billion-dollar Power Brands earning 68% of the company s revenues. These brands include Cadbury, Cadbury Dairy Milk, and Milka chocolate; LU, Nabisco, and Oreo biscuits; and Trident gum. Mondelez s Power Brands benefit from significant brand loyalty resulting in operating margins that are 1 to 2% higher than other brands. Power Brands also grow faster than the company average, therefore Mondelez plans to have them contribute to over 80% of total sales over time. Mondelez is considered the worldwide leader in biscuits, chocolate and candy, and holds a dominate position in gum. Its competitive advantage is that it sells snack items in complimentary food segments. This results in cost leverage, capability sharing and commercial marketing benefits. Moreover, it is able to take advantage of the vast distribution networks some of their subsidiaries have. Management is in the midst of implementing an aggressive growth strategy, which it hopes will help to increase its competitive advantage in the evergrowing space. Management hopes to grow organic revenue at or above the company growth rate, achieve operating income of high single digits (and double digits where possible) across all brands and double digit constant currency growth. EXHIBIT 1 Mondelez Popular Brands Mondelez has operations in approximately 80 countries around the world and distributes its products in over 165. EXHIBIT 2 EXHIBIT 3 Revenue Segmentation by Geography 2015A Revenue Segmentation by Product 2015A 10% 6% 9% 34% 16% 40% 16% 14% 26% Europe North America Latin America Asia Pacific EEMEA Source: Company Reports 30% Biscuits Chocolate Gum and Candy Beverages Cheese and Grocery Source: Company Reports 3
Industry Overview Over the past 5 years, the snack food industry has benefited from increased demand. This comes as a result of a strengthened economy, leading to higher discretionary spending levels. The industry is expected to grow at a 3.7% CAGR over the next 3 years, with total revenue expected to exceed $40B in 2016. The biggest headwind for producers in the snack is the ever-changing tastes and preferences of consumers. With many consumers beginning to embrace healthier lifestyles, snack food companies are feeling the need to offer new health-conscious items. Non-sugary snacks closely aligned with meal-replacement foods are showing the strongest growth of all areas, proving the movement by consumers to healthier alternatives. It is expected that improving economic conditions throughout North America and Europe will lead to increased demand for premium snacks. As such, companies have begun producing organic and whole food snack options to bring to the marketplace. EXHIBIT 4 Geographic Snack Consumption Breakdown 100% 80% 60% 40% 20% 0% 17% 31% 24% 28% 30% 26% 20% 24% 17% 17% 33% 28% 17% 19% 33% 36% 20% 25% 32% 23% Latin America Asia Pacific EEMEA Europe North America Confection Salty Cookies and Cakes Refrigerated Source: Nielsen Fruits and Vegetables There are four main drivers of the industry: per capita disposable income, the healthy eating index, the price of corn and the trade-weighted index. EXHIBIT 5 Percentage of Consumers Who Said They Ate These Snacks in the Last 30 Days Source: Nielsen Food Percentage Chocolate 64% Fresh Fruit 62% Vegetables 52% Cookies / Biscuits 51% Bread / Sandwich 50% Yogurt 50% Cheese 46% Chips / Crisps 44% Nuts / Seeds 41`% Gum / Ice Cream 33% Currently, there are three main companies operating in this industry: Mondelez, PepsiCo and ConAgra foods. Going forward, PepsiCo poses the largest threat to Mondelez because of their portfolio of household brands: Quaker s, Lay s, Dorito s and Fritos. As of 2014, confections (which includes sugary sweets such as chocolate, hard candy and gum) represented the largest sales contribution in Europe and the Middle East/Africa. Salty snacks were favourites in North America, representing roughly one-fifth of all snack consumption. Refrigerated snacks were consumed the most in Asia-Pacific, while cookies and snack cakes were best sellers in Latin America. 4
Investment Thesis I: Strong Brand Profile Mondelez s powerful presence in the snacking category is led by 7 billion-dollar Power Brands earning 68% of the company s revenues. These brands include Cadbury, Cadbury Dairy Milk, and Milka chocolate; LU, Nabisco, and Oreo biscuits; and Trident gum. Mondelez s Power Brands benefit from significant brand loyalty resulting in operating margins that are 1 to 2% higher than other brands. Power Brands also grow faster than the company average, therefore Mondelez plans to have them contribute to over 80% of total sales over time. pricing dynamics between Mondelez and their competitors are beginning to normalize and improve further into 2016. Mondelez has one of the lowest exposure to private labels out of the competition with just 10.6% of their portfolio composing of private label brands. This means that short-term increases in their cost base poses less of a risk, and Mondelez will continue to benefit from the strong brand loyalty which has been built over many decades. EXHIBIT 6 EXHIBIT 7 Leading Brands by Category Brand Exposure to Private Labels vs. Peers 20% 15% 10% 19.5% 16.6% 14.6% 13.2% 13.1% 11.9% 10.6% 10.2% Source: Company Reports In response to a shift in consumer preferences towards healthier snacks, Mondelez expects 50% of its product portfolio to be composed of Well- Being offerings by 2020, up from 35% today, aiming to become the global market leader in better-for-you snack options. The recent U.S release of Good Thins is the company s first new snack brand in over a decade and showcases their ability to provide relevant, healthier snacks at competitive prices. In order to retain future market share for the Power Brands, Mondelez is focusing on more aggressive marketing strategies (expected to climb to 10% of sales in 2018, a gain of 2%) and simpler, more nutritious ingredients. Mondelez s brands have seen shelf-space reduction at some retailers over the past 2 years as they took a price increase due to rising input costs earlier than competitors such as Mars and Nestle. These companies have hedges on their coca purchases that are longer-term than Mondelez. However, the 5% 0% KRFT MKC CAG SJM CPB GIS MDLZ K Source: Bernstein In order to focus on the core snacks portfolio and boost growth, Mondelez engaged in a spin-off of its coffee business in 2015 with D.E Master Blenders to create Jacobs Douwe Egberts (JDE). The new company, of which Mondelez has a 43.5% equity stake in, will leverage both company s share of the coffee market and cost savings are expected to total $1.5 billion by 2018. JDE sells coffee through industry leading brands such as Gevalia and Jacobs which achieve similar brand loyalty to Mondelez s Power Brands. Mondelez has the advantage of product offerings in complementary food categories, resulting in cost leverage and capability sharing. For example, in 2012 Mondelez launched Stride in China using its distribution network in biscuits. 5
Investment Thesis II: Emerging Markets Mondelez generates approximately 80% of its revenues from outside the U.S. It operates in more than 80 countries around the world, and sells products in over 165 countries. It is estimated that approximately 40% of Mondelez s revenues come from Brazil, Russia, China, India and Southeast Asia (BRIC nations). Over the past three years, we have seen numerous food and beverage companies move into the emerging markets as a result of their low per-capita consumption. This means that they have significant growth potential and are expected to gravitate towards name brands. Moreover, with a fast-growing middle class, the BRIC nations have increasing demand for convenience food and beverages. Snack food producers with strong brand portfolios will excel in this environment, In 2010, Mondelez acquired Cadbury limited, one of the world s largest chocolate manufacturers. In the years prior to the acquisition, Cadbury worked tirelessly to develop production and distribution networks in the BRIC nations. By acquiring Cadbury, EXHIBIT 8 2014 2015 Sales Growth by Geography 25% 20% 20% Mondelez is able to tap into the vast distribution networks in these emerging nations. So far, Mondelez has seen a 15% increase in its emerging market sales. Furthermore, Cadbury has significant presence in India which Mondelez is looking forward to capitalizing on. One of Mondelez s strategic objectives stated in their 2015 Annual Report is to revolutionize it s selling. To do so, they have made large changes to their marketing campaigns and have invested significantly in their BRIC nations marketing. This will help their access to key emerging markets. In 2015, Mondelez acquired an 80% stake in a Vietnamese biscuit manufacturer. This has helped them to expand operations and distribution routes in the Asia-pacific region. Moreover, Mondelez has invested significantly in it s e-commerce platform. They believe that a strong e- commerce platform will allow them to reach new customers, and increase margins. They hope that fuelling money into this platform will strengthen brand recognition in it s new key markets. 15% 10% 5% 0% 6% 4% 9% 2% 5% 0% 1% 2% -5% (2%) Asia Pacific Latin America EEMEA Europe North America Source: Company Filings, Nielsen Mondelez Net Revenue Global Snack Sales 6
$ Thousands QUIC Research Repor t Investment Thesis III: Margin Expansion Under pressure from activist investor Nelson Peltz and more recently Bill Ackman, Mondelez is undergoing a restructuring plan to expand the company s margins. In 2013, the plan was initially an increase of 3% to EBITDA margins. The key drivers in Mondelez s revamped plan for margin expansion lies in plant efficiency, reducing its complex system of 100,000 suppliers and 74,000 SKUs, and integrating Lean Six Sigma practices. First, Mondelez reduced the number of its employees in September 2015 in order to reduce the over-allocation of its work force. Analysts believe that a ~30% reduction of Mondelez s employees would bring their revenues on par with their Multinational peers who also operate in the emerging markets. However, this is a large target to hit, thus the management team has planned for other efficiency implementations to reduce costs. EXHIBIT 9 Multinational Revenue per Employee vs. Peers $750 $600 $450 $300 $150 $0 $224 Source: Company Reports $244 $265 $299 $371 $436 $693 BN ULVR NESN MDLZ HSY KHC PG A new, 250 acre lower-cost plant was established in Salinas, Mexico in the second half of 2015. Due to its proximity to suppliers, transportation routes, and a built-in distribution center, the plant requires 1/3 of the staffing of a regular manufacturing plant to produce the same capacity. The purpose of this plant is to help fuel growth in the Americas, and analysts believe that if 40% of sales in North America are produced in Salinas, the company will benefit from a 4% increase in gross margins. This year, Mondelez is expected to open two more similar plants in Russia and India, and by 2018 70% of Power Brands are expected to be produced in these lower-cost plants (an increase of ~45%). Moreover, one of Mondelez s goals is to increase efficiencies in plants which were garnered through acquisitions, yet never optimized. 40 advantage lines have been installed up to 2015, and 35 more lines are to be added by 2018. These lines are much more efficient due to a modular design that requires less production time, resources, as well as space. The implementation of these new advantage lines is expected to cut conversion costs by 20% around the globe. Overall, these cost-cutting efforts seem reasonable as Hershey, a competitor, achieved similar gains through almost identical procedures over the period of 2010 to 2014, even as cocoa prices doubled. Today, Mondelez faces less pressure from key input costs like coca, making their restructuring plan much more achievable. If Mondelez fails in its efforts, it will face pressures from the aforementioned activist investors to sell itself to Kraft-Heinz. However, a successful execution of this plan could lead to a merger with PepsiCo s Frito Lay; this has been discussed in depth in the past. EXHIBIT 10 Gross Margin Growth Over Efficiency Improvement Plan 45% 40% 35% 38.9% 36.8% 38.8% Source: Company Reports 42.8% 42.4% 40.3% 43.6% 41.1% Year 1 Year 2 Year 3 Year 4 Year 5 Mondelez Hershey 45.9% 41.9% 7
Catalysts and Risks 1. E-Commerce Expansion: On April 7, 2016 Mondelez formed an e-commerce partnership with China s leading online and mobile commerce company, Alibaba Group Holding Limited. The strategic deal is in line with the company s plans to expand e-commerce platforms and generate more online sales. 2. New Snack Brand Launch: On March 7, 2016 Mondelez announced the launch of its first new snack brand in more than ten years, named Good Thins. The new brand will offer low-fat and low-sugar snacks to meet the growing consumer demand for healthier products. 3. Healthy Eating: As part of the company s plan to offer healthier foods, Mondelez set 2020 goals of reducing sodium and saturated fat by 10%, increasing whole grains by 25% and placing calorie labeling on the front of packs of all relevant products by YE 2016. 1. Volume Trends: Since it s split from Kraft Food, Mondelez has seen weaker volumes as a result of higher pricing and category weakness. If this continues, they could experience a slowdown across all categories, which would lead to weakening revenues. 2. Venezuela Operations: Sugar supply in Venezuela has become scarce, forcing Coca- Cola to halt production of its sugary drinks. Although Mondelez has deconsolidated operations in the area at an impairment cost of $788 million, the location still remains a risk. Mondelez may have to freeze its production in the area as well and earn less cash from the new Venezuelan subsidiary 3. Foreign Exchange: With 80% of Mondelez s revenues coming from outside the U.S, foreign exchange will hurt the company s bottom line. In 2015, FX hurt revenue growth by 6%. Portfolio Fit We believe that Mondelez would be an excellent addition to the Consumers and Healthcare U.S portfolio. MDLZ has exposure to the fast growing snack food segment, and is also a financially stable company. Mondelez owns many power brands which are household staples across North America and Europe, while gaining massive growth in the emerging markets. Mondelez will serve as additional exposure to the food segment within our portfolio, which currently holds fast-serve companies in Starbucks and McDonald s. With intentions to sell, we propose a 15% stake in Mondelez for our current U.S portfolio, representing roughly a $4,000 investment. EXHIBIT 11 Proposed Consumer and Healthcare U.S Portfolio Allocation Starbucks Corporation 12% Merck & Co. Inc. 12% Mondelez International, Inc. 15% Lastly, we believe Mondelez provides durability in the consumer space that is currently experiencing massive threats to e-commerce. As a supplier of food products that does not sell in brick and mortar stores, we believe Mondelez will not only weather the storm, but also thrive in the ever-changing retail environment. McDonald's Corp. 17% Source: QUIC Data The Home Depot, Inc. 19% CVS Health Corporation 24% 8
Catalysts and Risks Comparable Company Analysis Company Name Market Enterprise EV / EBITDA Price / Earnings Net Debt / EBITDA EV/ Sales Dividend Cap ($MM) Value ($MM) LTM 2016E 2017E 2016E 2017E 2016E 2017E 2016E 2017E Yield The Kraft Heinz Company $100,219 $129,744 20.4x 16.9x 15.2x 26.7x 21.5x 2.7x 2.5x 4.9x 4.8x 2.8% Kellogg Company $26,009 $33,955 16.6x 13.4x 12.8x 20.1x 18.6x 3.1x 3.0x 2.6x 2.5x 2.7% General Mills Inc. $37,120 $46,307 13.4x 13.7x 13.4x 21.8x 20.6x 2.4x 2.3x 2.8x 2.8x 2.9% The Hershey Company $19,368 $21,722 13.0x 12.6x 12.1x 21.4x 19.9x 1.3x 1.3x 2.9x 2.8x 2.6% PepsiCo Inc. $144,586 $167,502 13.9x 13.3x 12.6x 21.2x 19.6x 1.8x 1.7x 2.7x 2.6x 3.0% Mean $65,460 $79,846 15.5x 14.0x 13.2x 22.2x 20.1x 2.3x 2.2x 3.2x 3.1x 2.8% Median $37,120 $46,307 13.9x 13.4x 12.8x 21.4x 19.9x 2.4x 2.3x 2.8x 2.8x 2.8% Mondelez International Inc. $67,297 $83,425 18.4x 17.1x 15.1x 23.6x 20.8x 3.3x 2.9x 3.1x 3.1x 1.6% Mondelez is trading at a small premium on a Price/Earnings, EV/EBITDA and Net Debt/EBITDA basis, and pays a lower yielding dividend than its peers. The company is slightly undervalued with regards to EV/Sales however, a ratio that indicates its future position if manufacturing efficiency is improved according to plans. EXHIBIT 11 QUIC Bernstein RBC Barclays Consensus Credit Suisse JP Morgan Goldman Sachs 42 44 46 48 50 52 54 9
Terminal Growth (%) QUIC Research Repor t Valuation We value Mondelez using comparable companies and a discounted cash flow model analyses. Cost of equity is derived by using a 10-year treasury yield of 1.85% and a market risk premium as calculated by Aswoth Damodoran. The cost of debt was calculated using the weighted average yield of MDLZ s debt. Combined, MDLZ s WACC is 5.7% - a low number due to the company s below average beta and cost of debt. We assumed a 2% terminal growth rate due to global expansion and MDLZ s particularly strong brand presence in emerging Markets. Our target share price implies a total return of 24.4% (capital gain of 22.8% and a dividend yield of 1.6%). WACC Calculation Risk-Free Rate 1.85% Market Risk Premium 6.12% Levered Beta 0.92x Cost of Equity 7.50% Share Price Calculation PV of UFCF 19,686 Terminal Year Growth Rate 2.00% Discount Rate 5.70% PV of Terminal Value 81,252 Enterprise Value 100,938 Cost of Debt 3.64% Tax Rate 22.00% After Tax Cost of Debt 2.84% Enterprise Value 100,938 Less: Total Debt 17,517 Plus: Cash and Cash Equivalents 1,338 Implied Equity Value 84,759 Capital Structure Debt 39% Equity 61% Total: 100% WACC 5.70% Shares Outstanding 1,598 Implied Share Price $53.03 Current Price $43.19 Target Price $53.03 Dividend Yield 1.6% Total Return 24.4% Discount Rate (%) $53.03 4.70% 5.20% 5.70% 6.20% 6.70% 1.00% $ 57.32 $ 48.62 $ 41.82 $ 36.38 $ 31.93 1.50% $ 66.21 $ 55.13 $ 46.76 $ 40.22 $ 34.98 2.00% $ 78.38 $ 63.69 $ 53.03 $ 44.97 $ 38.68 2.50% $ 96.10 $ 75.41 $ 61.27 $ 51.02 $ 43.26 3.00% $ 124.24 $ 92.46 $ 72.55 $ 58.94 $ 49.08 10
Appendix: Discounted Cash Flow Historical Period Projection Period 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Revenue 35,810 35,015 35,299 34,244 29,636 26,672 25,339 26,226 27,012 27,823 Year over Year Growth % (2.2%) 0.8% (3.0%) (13.5%) (10.0%) (5.0%) 3.5% 3.0% 3.0% Cost of Sales 22,710 21,939 22,189 21,647 18,124 15,923 14,925 15,237 15,667 16,137 % of Revenue 63.4% 62.7% 62.9% 63.2% 61.2% 59.7% 58.9% 58.1% 58.0% 58.0% Gross Profit 13,100 13,076 13,110 12,597 11,512 10,749 10,414 10,989 11,345 11,686 Margin % 36.6% 37.3% 37.1% 36.8% 38.8% 40.3% 41.1% 41.9% 42.0% 42.0% Operating Expenses 9,382 9,176 8,679 8,457 7,577 6,788 6,449 6,675 6,875 7,081 % of Revenue 26.2% 26.2% 24.6% 24.7% 25.6% 25.5% 25.5% 25.5% 25.5% 25.5% EBITDA 3,718 3,900 4,431 4,120 3,935 3,961 3,965 4,314 4,470 4,604 Year over Year Growth % 4.9% 13.6% (7.0%) (4.5%) 0.6% 0.1% 8.8% 3.6% 3.0% Less: Depreciation and Amortization 225 217 217 206 181 164 156 161 166 171 % of Revenue 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% EBIT 3,667 3,894 4,465 4,182 3,862 3,797 3,809 4,153 4,304 4,433 Year over Year Growth % 6.2% 14.7% (6.3%) (7.7%) (1.7%) 0.3% 9.0% 3.7% 3.0% Less: Income Taxes 932 1,057 760 1,238 745 835 838 914 947 975 Effective Tax Rate 25.4% 27.1% 17.0% 29.6% 19.3% 22.0% 22.0% 22.0% 22.0% 22.0% Net Operating Profit After Taxes 2,735 2,837 3,705 2,944 3,117 2961 2971 3239 3357 3458 Year over Year Growth % 3.7% 30.6% (20.5%) 5.9% (5.0%) 0.3% 9.0% 3.7% 3.0% Plus: Depreciation and Amortization 225 217 217 206 181 164 156 161 166 171 Less Capital Expenditures -1,771-1,610-1,622-1,642-1,514 1,283 1,218 1,261 1,299 1,338 % of Revenue 4.9% 4.6% 4.6% 4.8% 5.1% 4.8% 4.8% 4.8% 4.8% 4.8% Less: Change in Net Working Capital 423 1,116-1,063-426 -623-114.6-114.6-114.6-114.6-114.6 Unlevered Free Cash Flow 1,612 2,560 1,237 1,082 1,161 4,293 4,231 4,547 4,708 4,852 Discount Period 0.5 1.5 2.5 3.5 4.5 Discount Factor 97.3% 92.0% 87.1% 82.4% 77.9% Present Value of Unlevered Cash Flows 4,176 3,893 3,958 3,878 3,781 11
References 1. Bloomberg 2. Capital IQ 3. Company Filings 4. IBIS World 5. Nielsen 6. JP Morgan 7. Morgan Stanley 8. RBC Capital Markets 9. Scotiabank Global Banking and Markets 10. UBS Securities 12