A number of ingredients go into making profits at global food companies. One leaven is focusing on hot trends that reflect shifts in consumer eating patterns. Another is strong management.

Maryland-based spice producer McCormick & Co. Inc. is a case in point. It is front and centre in the growing interest in ethnic foods. Battle Creek, Mich.-based Kellogg Co. and Northfield, Ill.-based Kraft Foods Inc. take the other approach.

Kellogg — the bulk of whose business remains in the generally slow-growth breakfast cereals category — has managed to be innovative and is increasing market share, pricing and margins, says Patricia Fee, money manager at IG International Management Ltd. in Dublin. As a result, a number of analysts consider the company a good investment bet.

Kraft has a new management team that could give the company a more focused approach, says Charles Burbeck, head of global equities at HSBC Halbis Partners in London, making it a possible investment.

“[Food companies] are making better use of technology to manage their businesses on profitability instead of volume, setting more realistic expectations and returning more cash to shareholders,” states a report by Credit Suisse Securities (Europe) Ltd. in London, noting this wasn’t the case five years ago.

Here’s a closer look:

> Kellogg Co. With organic sales growth expected to be about 7% this year and 5%-6% in 2007 (vs 1%-3% for competitors), Fee believes, Kellogg’s already high 18% operating margins will go even higher. The company is in control of costs, she says, and will benefit if the recent declines in commodity prices are sustained. If commodity prices decline further, it will do even better. Fee expects earnings per share to grow by 11%-12% and notes that few other U.S. food companies are able to achieve EPS growth of more than 10% a year.

Fee also sees upside price potential of 10%-15% within the next year for the company’s shares, which were trading at US$50 a share on the New York Stock Exchange in late October. That is about 20 times Burbeck’s estimate of 2007 earnings. There are 395.7 million shares common outstanding.

In reports issued in August, New York-based Bernstein Investment Research and Manage-ment had a 12-month target share price of US$60; Stamford, Conn.-based UBS Securities LLC’s target was US$58.

UBS expects 2007’s margin expansion to come from price increases; self-funding of up-front costs; innovative new cereal products focusing on digestive, heart and brain health; higher effectiveness from advertising; and bringing in-house manufacturing that was previously contracted out.

In addition, UBS wrote, Kellogg could benefit from “strategic bolt-on” purchases of snack product lines in Asia and cereal and snack lines in Eastern/Central Europe. Another buy might be the grain-based hot and cold cereal products that Kraft may wish to sell.

Over the longer term, Bernstein believes, Kellogg should be able to sustain higher sales growth than other food companies for a number of reasons:

> it has the opportunity to expand snack food sales in international markets, particularly the highly profitable Latin American market;

> it has a strong and growing position in the U.S. adult-oriented healthy cereals market, on which it is more focused than Kraft or Minneapolis-based General Mills Inc.;

> its global portfolio is arguably the strongest among the major packaged food players; and

> it has boosted its advertising spending and expects to keep increasing it at a pace slightly higher than sales growth.

Yet Burbeck is unenthusiastic about Kellogg, saying that with margins already high — he estimates a 19% profit margin in 2007 and a 43% return on equity — there is less scope for improvement than with other companies. Nevertheless, he says, “It is not a bad investment.” It’s a well-run company with growth opportunities in the U.S. and internationally.

Kellogg reported net income of US$821.7 million in the nine months ended Sept. 30, up from US$788 million in the same period the previous year. Net sales were US$8.3 billion in the nine months vs US$7.8 billion a year earlier. Long-term debt was US$3.1 billion.

Two-thirds of Kellogg’s sales are in the U.S., 20% are in Europe, 8% in Latin America and 5% in Asia Pacific. Latin America is the most profitable region, providing an 11% share of operating income.

> Kraft Foods Inc. According to Burbeck, Kraft is a more interesting long-term investment than Kellogg because of the former’s new management team. In June, Kraft hired a new CEO, Irene Rosenfeld, who was recently chair and CEO of Frito-Lay, a division of New York-based PepsiCo. Inc.

@page_break@In September, Rosenfeld made significant changes in the executive team aimed at building a “bolder, more agile, more creative and more focused” company, reported Bernstein. She has also moved day-to-day operational decision-making back to the regional level.

Burbeck points out there could be even more scope for restructuring and acquisitions. Kraft is 88.6%-owned by New York-based Altria Group, which will decide at a board meeting in January whether to divest its 1.5-billion shareholding in Kraft by dispersing the Kraft shares it holds to Altria shareholders. Altria itself has 2.1 billion shares outstanding; Kraft’s 1.7 billion publicly held shares trade on the NYSE.

Burbeck estimates Kraft’s operating margins will be 15% in the fiscal year ending Dec. 31, 2007; its ROE, 9%. Bernstein, in its August report, wrote that Kraft’s margins will probably expand as a result of cost savings from restructuring and the easing of commodity prices. The report also noted that Kraft invests a good deal in its brands and on advertising, so it shouldn’t have to ramp that up.

Bernstein has set a 12-month target of US$40 a share for Kraft; it was trading at US$35 a share in late October, or at about 18 times Burbeck’s 2007 earnings estimate.

New-York based Argus Research Co. , however, maintained its “hold” on the company in its report released in late October, following “somewhat disappointing third-quarter results.” UBS was even more pessimistic. It has lowered its price target to US$32 a share from the US$35 it set in August and recommended clients reduce their holdings. UBS is expecting input cost inflation for cheese and grains, increased reinvestment in innovation and marketing, and the potential for dilutive divestitures.

UBS is also concerned that Altria’s spinoff of its Kraft shares will cause a short-term drop in Kraft’s share price as some Altria shareholders sell all or part of their Kraft holdings. But UBS also noted there are long-term benefits for the spinoff, such as inclusion in the benchmark Standard & Poor’s 500 composite index, increased management autonomy and removal of the tobacco taint. (Altria’s other major holding is 100% of Philip Morris Cos. Inc.)

Kraft reported net income excluding unusual or non-recurring items of US$2.4 billion in the nine months ended Sept. 30, vs US$2.1 billion in the same period a year earlier. Revenue was US$25 billion in the nine months, up 2.2% from US$24.5 billion the previous year. Long-term debt was US$7.1 billion; other long-term liabilities, consisting primarily of severance and incentive compensation arrangements but excluding accrued pension and post-retirement health care and post-employment costs, was US$4.8 billion.

Snacks and cereals accounted for 28% of Kraft’s U.S. sales in the nine months, with cheese and food service at 25%, convenience meals at 21%, beverages at 14%, and groceries, including deserts, cereals, rice and condiments at 12%. Geographically, the U.S. accounted for 69% of sales, the European Union for 18% and the rest of the world for 13%.

> McCormick & Co. Inc. Although this spice producer is much smaller than Kellogg and Kraft, it’s a firm in the right category. With more ethnically diverse cities and a greater tendency for people to eat out, consumers are developing a taste for spicier foods, says Burbeck. McCormick’s business is also a very profitable because it can sell small quantities in nice packaging.

The firm has solid growth opportunities in both its consumer and industrial businesses. CEO Bob Lawless estimates its key industrial accounts are bringing in only 25% of potential business.

Burbeck — who expects the company’s operating margin to be 14% and its ROE to be 25% in its fiscal year ending Nov. 30, 2007 — puts potential EPS growth at 12%-15% over the next three to five years. However, McCormick’s 131.8 million widely held shares, of which only 13.7 million are voting shares, aren’t cheap. In late October, they were trading on the NYSE at US$37 a share, or about 21 times 2007 earnings. Burbeck calls the company a “good long-term proposition” but “not compelling” in the short run.

Credit Suisse, too, thinks McCormick’s share price is a bit high. In a Sept. 27 report, it had a 12-month target of US$36 a share.

McCormick reported net income before restructuring charges of US$136.3 million in the nine months ended Aug. 31, up from US$127.2 million the previous year. Revenue was up only 3.1% to US$1.9 billion. Long-term debt was US$566.1 million.

By 2008, the company expects to see US$34 million after taxes in cost savings from restructuring. IE