Mondelez International (NASDAQ: MDLZ) stock and several of its peers in the food industry have underperformed the S&P 500 over the last five years. This is largely because sales growth has been very difficult to come by, as consumers are turning away from sugary, heavily processed foods in favor of healthier choices.
Still, Mondelez stock is up about 61% since late 2012, which is much better than some of its peers, including The Hershey Company (NYSE: HSY), Kellogg's (NYSE: K), and General Mills (NYSE: GIS), which are up anywhere from about 35% to 45%.
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We'll take a look at Mondelez's valuation and growth expectations to determine whether Mondelez is overvalued or still a good investment at current valuation levels.
Taking a look at the price-to-earnings (P/E) ratios of these food companies, what immediately jumps out is Mondelez is trading right around the middle of the pack on the basis of trailing P/E. Even on the basis of forward looking estimates of earnings per share, Mondelez trades lower than Hershey, and only a little higher than Kellogg and General Mills.
Why are the cereal giants (Kellogg and General Mills) trading for lower P/E ratios? Take a look at the analyst growth estimates for the next five years. The cereal stocks are expected to grow 6% per year, which is not only less than Mondelez and Hershey, but it's even less than the expected earnings growth of 10% for the S&P 500 -- a diversified index that tracks 500 of the largest U.S. based companies. Generally, companies that can deliver higher growth are awarded higher P/E ratios by investors.
Analysts expect Mondelez to grow earnings at least 10% per year over the next five years, which is higher than the others. There is no analyst estimate available for Kraft Heinz, probably due to the fact it doesn't issue guidance, but Kraft Heinz should grow comparably to Mondelez using recent earnings performance as a guide. Both Kraft Heinz and Mondelez are dealing with very slow top line growth, but both are cutting unnecessary costs, expanding margins, and posting double-digit earnings growth lately.
So how can Mondelez deliver double-digit earnings growth over the next five years and justify its 20 P/E? In recent years, Mondelez has been the target of activist investors who see the snack food giant underperforming its peers on the basis of margins, which is evident here:
Management has been listening to the concerns of these investors and has taken the initiative to not only grow earnings, but improve sales performance also. Mondelez has been shedding non-core assets, such as its coffee business, as well as disposing underperforming facilities to improve its overall efficiency throughout the company.
Along with those efforts, management has been focused on improving its marketing and innovation around what they call Power Brands -- including Oreo, belVita, Trident gum, and Halls cough drops. Power Brands make up 70% of Mondelez's global revenue and are growing at twice the rate of the company overall and are also growing faster than other brands in the same category. Management has been investing in these profitable brands in markets where they see the best returns on investment.
The biggest challenge Mondelez faces is the consumer backlash against heavily processed foods. Management is addressing this issue by introducing new well-being snacks that are marketed for their exclusion of artificial coloring, preservatives, and other "unhealthy" ingredients.
A final key growth initiative is e-commerce where Mondelez grew net revenue 35% in 2016. Mondelez has formed partnerships with Amazon.com, Alibaba, U.K.-based grocer Tesco, and Wal-Mart Stores to build a best-in-class online snack business. Management is aiming to grow e-commerce net revenue to more than $1 billion.
These initiatives have been working. Mondelez has been able to post positive organic net sales growth, but at only 1.3% in 2016, there's still a lot of work to do. Nonetheless, management has delivered on their goal to expand adjusted operating margin from about 12% to over 16% during the last five years, and that has fueled the 61% increasing the stock price over the same period.
Mondelez is not overvalued
Management's guidance calls for double-digit adjusted earnings-per-share growth in 2017, as well as plans to expand adjusted operating margin from about 16.5% in 2017 to 17%-18% over the next few years. Given the progress the company has already made, these targets seem very credible, and should allow Mondelez to continue growing earnings, paying a dividend, and delivering returns for shareholders. In my opinion, Mondelez is not overvalued.
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