Investors Confident in Kraft Turnaround

Kraft Foods Inc. (NYSE: KFT) may be trading near their 52-week lows, but investors remain confident in a turnaround. The food processing company should experience a boost from lower commodity prices and successful price hikes on much of its inventory. Meanwhile, billionaire investor Warren Buffett also holds a large $2.53 billion stake in the company that he purchased at higher prices, which gives many investors confidence in the value of the company.

Kraft Foods expects to experience cost savings from restructuring, lower commodity prices and economic conditions that encourage people to eat at home. Fast food competitors are being forced to raise their prices to cope with higher food costs, which should result in an exodus towards processed food offered by Kraft and others. Analysts have realized these trends with both UBS and Merill Lynch boosting their ratings on the stock.

Kraft Foods is also trading at a very reasonable valuation of 18x earnings while paying a healthy yield of 3.96 percent. This is very comparable to competitors like General Mills (GIS), despite the fact that Kraft pays a healthier dividend that should encourage a higher multiple. Many are expecting these financials to improve with future top and bottom line growth expected. Moreover, Buffett’s comments in his recent column in the New York Times added more confidence to the fire.

So, how can investors best take advantage of this value in Kraft Foods? Purchasing stock requires a lot of upfront cash while putting all the capital at risk. A better option may be to purchase long-term options on the stock, known as Longterm Equity Anticipation Securities or LEAPS. The January 2010 LEAPS represent some of the best deals. The $30 strikes are traidng at just $3.87 per contract while the $35 strikes are trading at $2.35 per contract.

Investors that believe Kraft is headed past $40 between now and January of 2010 may want to purchase the $35 strikes. The cost would be $235 to own the rights to 100 shares at $35 per share. So, if the stock did hit $40 per share, they would be able to immediately sell their position for $5 per share in profit, or $500, for an initial investment of just $235. This represents a 100%+ return compared to a 30% return gained by purchasing the underlying stock. Additionally, only $235 is at risk compared to $3,000 at risk seen purchasing the underlying stock.

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