Dow Industrials Face Potential Shakeup as Kraft Split Looms

Dow Industrials Face Potential Shakeup as Kraft Split Approaches
Kraft is separating its global snacks business, which will be renamed Mondelez International Inc., from its grocer business. Photographer: Daniel Acker/Bloomberg

The new owners of the Dow Jones Industrial Average will face their first decision on how the 116-year-old gauge should be composed when Kraft Foods Inc. splits itself in two later this year.

Kraft, with a $69.3 billion market value that’s ranked 20th in the 30-stock gauge, may be dropped because the spinoff of its U.S. grocery business will shrink the world’s second-largest food company, said Keith Wirtz at Fifth Third Asset Management. Hewlett-Packard Co. and Alcoa Inc. are vulnerable after losing almost half of their value in the past year, according to Richard Moroney, editor of the Dow Theory Forecasts newsletter.

“Kraft’s market cap is not going to be big enough to make them a certain stock to stay in,” Moroney, who manages $165 million at Hammond, Indiana-based Horizon Investment Services, said in a phone interview this week. The selection committee is “always clear that any sort of corporate actions put all 30 components up for grabs. I wouldn’t be surprised to see a switch.”

The Dow, which began in 1896 with General Electric Co., American Tobacco and 10 other companies, was taken over last week by S&P Dow Jones Indices, a joint venture of McGraw-Hill Cos. and CME Group Inc. About $28 billion in products such as exchanged-traded funds are linked to the index, and changes prompt money managers to buy or sell stocks to match the adjustments.

Rare Change

Changes in the composition of the average “are rare, and generally occur only after corporate acquisitions or other dramatic shifts in a component’s core business,” according to the S&P Dow Jones Indices Web site. “When such an event necessitates that one component be replaced, the entire index is reviewed,” and “multiple component changes are often implemented simultaneously,” it said.

Dave Guarino, a spokesman for S&P Dow Jones Indices, declined to comment on potential additions and deletions.

Kraft is separating its global snacks business, which will be renamed Mondelez International Inc., from its grocery business. Mondelez will retain about $35 billion in annual sales from brands including Cadbury chocolate and Oreo cookies, while the grocery company will have about $19 billion in revenue, based on 2011 results, Michael Mitchell, a spokesman for Kraft, said in an e-mail today. The company is on track to complete the spinoff before year-end, he said.

‘Solid Growth’

“Whether we remain a component in the Dow Jones Industrial Average is not our decision,” Mitchell said in a separate e-mail earlier this week. “We will remain focused on what we can control: maintaining strong business momentum and driving solid growth for our shareholders.”

Past spinoffs have led to deletions. Altria Group Inc. was dropped in February 2008, one month before the divestiture of its overseas tobacco unit and almost one year after its spinoff of Kraft. Westinghouse Electric Corp.’s split into separate manufacturing and media companies led to its removal in 1997.

“It’s a reasonable expectation that Kraft is a member change in the Dow Jones,” Wirtz, who oversees $15 billion as chief investment officer for Fifth Third in Cincinnati, said in a July 9 phone interview. “Whenever you have a strategic adjustment, a restructuring, it always elevates it to a possibility.”

AIG Replaced

Kraft joined the Dow in September 2008, replacing American International Group Inc. when the insurer’s 97 percent plunge that year spurred a federal bailout amid the U.S. subprime-mortgage crisis. The stock has a market value of $69.3 billion, compared with the average of $127.8 billion for the 30 constituents in the Dow, data compiled by Bloomberg show.

Alcoa is the smallest company in the index with a market value of $8.8 billion, about a third the size of Travelers Cos. The New York-based aluminum producer weakened after a supply surplus led to a 23 percent drop in prices for the metal during the past year.

Hewlett-Packard, the Dow’s worst performer this year, fell 1.7 percent to $19.35 at 4 p.m. in New York. The market value for the Palo Alto, California-based company has shrunk to $38 billion, compared with $560 billion for rival computer maker Apple Inc. Sales at Hewlett-Packard have fallen three straight quarters as consumers shifted to tablets and demand for printers and data-center gear slowed.

Apple, Google

Apple, the world’s largest company by market value, may be included in the index if the selection committee changes its methodology to include higher-priced stocks, according to Moroney at Horizon. The company, along with Google Inc., has been passed over because the shares would command the biggest weightings in the index, which ranks stocks by price.

Apple, based in Cupertino, California, closed at $598.90 while Mountain View, California-based Google traded at $570.48. That’s more than three times the price of International Business Machines Corp., the Dow’s largest component with an 11 percent weighting. The price difference between shares could be reduced by adding an individual-stock divisor, Moroney said.

“How can you have an index of the bluest of blue chips and not have Apple?” Moroney said. “It’s in their interest if they want money to be indexed to the Dow and they want more people to continue to look at the Dow as a barometer of leading stocks.”

Comcast Corp. and Qualcomm Inc. are also candidates, he said.

Selection Committee

The selection committee for the Dow average may decide not to change the components because the gauge still reflects the broad market and moves in line with the Standard & Poor’s 500 Index, said Jeffrey Yale Rubin, an analyst at Birinyi Associates Inc. in Westport, Connecticut.

The Dow, which accounts for 24 percent of U.S. stock market value, added 1 percent in the past year, compared with a 1.6 percent gain in the S&P 500. The broader measure for U.S. equities represents 76 percent of the market, according to data compiled by Bloomberg.

“There is no rule written in stone that because nothing has been done in three years that something needs to be done,” Rubin said in a phone interview this week.

The 30-stock average was last reshuffled in June 2009, when Cisco Systems Inc. and Travelers replaced General Motors Corp., which filed for bankruptcy protection, and Citigroup Inc., the recipient of $45 billion in taxpayer aid.

Comcast, Qualcomm

Moroney predicted that Comcast and Qualcomm may be added to the Dow because they are leaders in their respective industries. Comcast, the largest U.S. cable company with a market value of $83.6 billion, has climbed 31 percent this year to $31.10. Inclusion of the Philadelphia-based company would make it the second media company after Walt Disney Co. and rank it before Microsoft Corp., the 23rd most weighted stock in the Dow, data compiled by Bloomberg show.

Qualcomm, the largest maker of mobile-phone chips valued at $92 billion, fell 1.2 percent to $53.73 and is down 1.8 percent this year. The San Diego-based company would rank ahead of Home Depot Inc., the 15th biggest in the Dow.

The Dow average was devised by Charles H. Dow, co-founder of Wall Street Journal publisher Dow Jones & Co. Originally containing 12 stocks, it expanded to 20 companies in 1916 and to 30 in 1928. The stocks in the index must have an “excellent” reputation and show sustained growth, according to the S&P Dow Jones Indices Web site.

-- Editors: Steve Chambers, Lynn Thomasson

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