Mondelez stock: richly valued, but still a solid income investment

Investment thesis

Basically, Mondelez (NASDAQ:MDLZ) is a very solid company. The company focuses on its most dynamic segments and acquires new products. But the company is trading at a high valuation with high leverage. I think it’s a decent buy for defensive income investors, but I think the long-term upside is limited.

Strong performance in core segments

Mondelez’s activity is very strong. During the last quarter, the company increased its revenue by 13.1% year over year at constant exchange rates. EPS in constant currency reached $0.72, an increase of 9.1%.

Mondelez calls its cookies segment and its chocolate segment its core businesses. The Cookies segment includes cookies, crackers and savory snacks. These key segments represent a growing share of the business. In 2012, these accounted for 54% of turnover. Last year, they accounted for 79% of turnover.

Mondelez’s core businesses have shown extremely impressive organic growth in recent years. During the last quarter, Mondelez’s biscuit segment grew 10.4% year-over-year, including volume growth of 2%. Its chocolate segment was even stronger, growing 30% year-over-year. 9% of this growth was in volume.

The brands in these segments constitute the strong moat of Mondelez. The company owns many iconic brands, such as Oreo, Triscuit, Cadbury and Toblerone. Private label products are not very competitive in Mondelez’s core business categories. Even though it is increasing prices, Mondelez is not reporting a drop in volume. Management does not see consumers opting out or turning to cheaper brands. This strong brand loyalty makes the company extremely resilient to today’s economic headwinds.

Inflation always has a significant impact on business operations. Even as commodity inflation begins to ease, labor inflation is now a new headwind. Mondelez has been effective in offsetting inflation with increased prices. The company increased its gross profit by 9.7% year-on-year. It recently completed its final round of price increases for 2022. Management expects another round of increases in 2023 to offset expected inflation.

This strong performance prompted the company to raise its long-term expectations. The company has set its long-term goal at 3% to 5% annual revenue growth. Management expects high single-digit annual EPS growth. They are on track to meet their free cash flow target of $3 billion.

Long-term transformation of Mondelez

In the long term, Mondelez is focusing on its biscuit and chocolate segments. Management aims to slowly divest the 20% of its business that is in non-strategic segments. These segments include gum, candy, cheese, groceries and powdered beverages. For example, the company recently announced its intention to divest part of its Trident and Halls brands. At the same time, the company is spending heavily to acquire new business in its core segments. Management explained its decision at a recent investor conference.

Yes. Well, maybe I’ll start by quickly saying why we love these categories so much. Our two categories were the brands play a big role. They grow quite well. Our business has grown approximately 6% over the past 3 years. MDD is very limited in categories. It’s expandable consumption, if you will, which makes it interesting. And we still see plenty of opportunities around the world for significant growth in this category. So we love them and we’re doing pretty well.

So from our perspective, if our business was just cookies and chocolate, we would see a much stronger top line and we would see a much stronger bottom line. And we think that’s where we have to gradually move towards — that movement will be through a balance between acquisition and divestment, I would say. There is 20% of our activity. It’s not in both categories. And that’s really over time, where we’ll go out and try to combine that with a number of acquisitions.

The company has invested heavily in this strategy. It has spent nearly $6.3 billion on acquisitions since the pandemic began. These are expected to increase Mondelez’s revenue by $2.8 billion at closing.

In June, the company announced its acquisition of Clif Bar & Company. The brand strengthens Mondelez’s presence in the snack bar market. Management believes the brand is also positioned to expand internationally. Today, the category is mainly concentrated in the United States. As it expands to the rest of the world, Mondelez is well positioned to benefit.

I like this strategy. Mondelez is focused on acquiring new brands in its core markets. It’s a good opportunity for management to grow in the segments they want more exposure to. These include dark chocolate and premium chocolate brands. By focusing on these segments, the company has the ability to generate a higher return on investment. The company can leverage its existing manufacturing and distribution network. This leads to strong incremental revenue growth, which is an effective way to increase profits.

Mondelez is a market leader in each of its key segments. The company is the world’s leading biscuit company with a market share of around 16%.

The company is also developing its chocolate segment. It’s closing in on Mars’ title as the number one chocolate brand.

I like Mondelez’s strategy and think the company is well positioned to execute it. But mergers and acquisitions remain expensive and require a significant use of capital. Since 2019, the company has spent almost 43% of its free cash flow on acquisitions. The company’s buybacks, dividends, acquisitions and capital expenditures accounted for nearly 150% of free cash flow last year. The company will likely have to cut shareholder returns or acquisitions. So far, the company has funded this strategy by increasing its leverage.

High leverage, expensive valuation

Mondelez trades at a forward P/E of 19x and a forward EV/EBITDA of 15.7x. His LTM P/FCF is 22.5. At the current valuation, the company has a free cash flow yield of 4.5%. I think this valuation is high for a company with a long-term single-digit organic growth forecast.

The company has strong liquidity, with over $2 billion in cash and $9 billion in unused credit lines. He also has nearly $20 billion in debt and other obligations. The company’s recent acquisition of Clif will increase that figure by approximately $2.9 billion. This combined debt burden is approximately 4.6 times EBIT LTM. I think it’s high, but the company should be able to handle it. I still want to see Mondelez reduce leverage in the next few years.

Mondelez also has significant stakes in other companies. The largest of these are his 6.4% stake in Keurig Dr Pepper (KDP) and his 19.8% stake in JDE Peet’s (OTCPK:JDEPF). According to my estimates, these two investments are worth $6.2 billion. Management is reducing its holdings to fund its mergers and acquisitions strategy.

The company pays a strong dividend, yielding 2.8%. This dividend is well covered by free cash flow and results. The company has also done a good job of increasing this dividend. Since its separation from Kraft Foods in 2012, Mondelez has increased its dividend at an impressive CAGR of 12%.

In the first half of the year, the company spent $1.5 billion on stock buybacks. The company is on track to reduce its share count by 25% between the end of 2012 and 2022. This demonstrates management’s commitment to returning free cash flow to shareholders.

But shareholder returns have often exceeded the company’s organic free cash flow. This is before considering its cash acquisitions. I think Mondelez will eventually have to choose between reducing its debt, continuing its M&A strategy and returning cash to shareholders.

final verdict

I like Mondelez’s strategy. The company focuses on segments where it is strongest instead of trying to grow in unproven categories. The company has strong liquidity and generates strong returns for shareholders.

The expensive valuation of the company and its increasing leverage are my main concerns. I think it can be a good choice for income investors. But I would look elsewhere if your primary goal is total return.