Mondelez Stock: Stay Off The Cookies (NASDAQ:MDLZ)

Over the summer, I concluded that I was not taking a bite in Mondelez (NASDAQ:MDLZ) as the consumer food giant had become somewhat of an M&A machine as of late. Bolt-on dealmaking was accompanied by solid operational growth as valuations looked fair, yet I concluded that few triggers were seen in a rapidly rising interest rate environment.

Some Perspective

Mondelez is a global snacking empire, home to brands like Oreo, Milka, Cadbury, and many other well-known snacking brands. These businesses have come somewhat under pressure on the back of ESG concerns, as the food is not so healthy for consumers, while the impact on the environment is under scrutiny as well, relating to the use and production of palm oil and cacao, among some other key ingredients.

To combat this, Mondelez believes that snacking should be done right for the environment and consumers, as these transitions, both in terms of consumers’ taste and production, will take years or even decades. In the pandemic year 2020, the company posted stable results, having sold $26.6 billion of such snacks, posting solid operating earnings in the process. This resulted in net earnings of $2.2 billion, equal to $1.50 per share (on a GAAP basis) as this resulted in a huge multiple given that share traded hands around the $60 mark.

The balance sheet was a bit complicated as the company held a stake in JDE Peet’s as well as an 8% stake in Keurig Dr Pepper. Factoring in the value of these investments, the company operated with net debt of $10 billion in 2020, resulting in a 2 times leverage ratio based on $5 billion in EBITDA. Adjusted earnings came in at $2.59 per share, more than a dollar per share higher than GAAP earnings, yet I pegged realistic earnings somewhere in the middle, at around $2 per share.

The company has seen a solid 2021, with sales up 8% to $28.7 billion, driven by volume, pricing, and acquisition. Adjusted earnings per share rose 9% to $2.87 per share, with no formal guidance issued for 2022. With shares trading at $60 per share, equity of the company was valued at $84 billion, or nearly a $100 billion enterprise valuation if we factor in a net debt load of $12.5 billion. With earnings seen at nearly $3 per share, adjusted earnings multiples fell toward 20 times. The business was valued at just around 3.5 times sales as the company has seen momentum following a $1.3 billion deal to acquire Mexican-based Ricolino earlier this year, as well as a $2.9 billion deal to acquire Clif Bar & Company.

With the company having announced nearly 10 deals since 2018, these transactions added some $3 billion to reported sales, as dealmaking makes that pro forma net debt will increase to $16.8 billion, still below 3 times if we believe EBITDA trends at a $6 billion. With the adjusted earnings coming in at 5%, the situation looks compelling from an earnings point of view, yet the stable performance and higher earnings yield in risk-free rates make that the relative appeal was not so impressive, leaving me cautious given levels of interest rates, yet I was upbeat on the business.

Holding Up

Shares of Mondelez traded around the $60 mark over the summer, as shares fell to the $55 mark in October amidst rising interest rates creating headwinds from a valuation perspective. As rates have cooled off a bit in recent times, shares have risen to $67 at this moment of writing, trading near their highs.

The company posted resilient second quarter results over the summer as the company raised the organic revenue growth number to more than 8%, aided by pricing, of course. The company closed on the acquisition of Ricolino and Clif Bar during the third quarter, hiking the organic revenue and EPS outlook, both seen up more than 10%. This made that net debt rose rather aggressively to $19.5 billion, a number which falls to $15.0 billion if equity method investments are taken into account.

Through the first three quarters of the year, adjusted earnings rose eight cents to $2.22 per share (with adjusted earnings coming in at $2.41 per share if we factor out the currency movements). GAAP earnings came in at $1.54 per share, with the adjustment largely relating to acquisition-related costs, derivative losses, debt extinguishment costs, and some other items.

With 1.38 billion shares now trading at $67, the company now commands a $92 billion equity valuation, or about $111 billion if we factor in net debt. With revenues now trending around $30 billion, the company trades at 3.7 times sales. Despite the ambitions, the company continues to pay out solid dividends, now running at $0.385 per share on a quarterly basis, or $1.54 per share, for a yield just in excess of 2%. The company has been trying to make the dividend competitive in a rapidly rising interest rate environment, as the company hiked the dividend by 10% this year.

Trying to address some of the build-up in leverage following elevated dealmaking in recent times, Mondelez resorted to a small sale as well. Towards the end of 2202, the company announced that it reached a deal to sell its developed gum business to Perfetti Van Melle. Mondelez will fetch $1.35 billion, or approximately 15 times the annual EBITDA of $90 million in the deal with no revenue contribution reported.

The deal involves well-known gum names like Trident, Dentyne, Stimorol, Hollywood, and V6, among others. The deal looks quite fair in all honesty, although the question can be asked if moving from chewing gum to chocolate, biscuits and baked snacks is really the right move given the upcoming transition and perhaps long-term challenges to the business.

And Now?

The truth is that realistic earnings come in around $3 per share, and pegging realistic earnings around $2.50 per share, I am careful here. Using the $2.50 per share number, the company trades at 26-27 times earnings.

This makes me very cautious given the levels at which interest rates are trading, despite the defensive qualities of the business and truth be said solid operating performance of the company. Moreover, leverage is substantial, even after the recent sale, as I am still reiterating my cautious tone this summer.

I like the performance of Mondelez, yet in relation to the alternatives, shares have to come down as well, before creating a compelling risk-reward here.