Buy, Sell or Hold: Brace for Inflation with Kraft Foods Inc. (NYSE: KFT)

Growing up in the 1970s, I remember seeing fears of food inflation affect the life around me.

My parents purchased a small farm and put in an

organic garden so that we would always have food. My mom was always canning food and my father was riding the tractor. They had grown up in the 1930s and remembered the key to surviving tough economic times was to be able to feed yourself when you needed to.

Today, we have a generation of fast food buyers. But the problem with that diet - besides its impact on your health - is that it is not as cheap as it once was. People will have to change their spending habits if they're going to cope with inflation.

That means more eating in, which is good news for Kraft Foods Inc. (NYSE: KFT). Kraft is a great source of inexpensive food - particularly for the millions of Americans signing up for food stamps.

The company today known as Kraft Foods was formed on December 10, 1923. The company changed hands over the next few decades and was purchased by Philip Morris Companies - now known as Altria Group (NYSE: MO) - in 1988.

Kraft began operating independently of Altria Group in March 2007, and in 2008 replaced American International Group Inc. (NYSE: AIG) as a component in the Dow Jones Industrial Average.

Kraft has what I consider a bulletproof business plan. It is both diversified, but sector specific. It has scales of economy working for it, where smaller firms are going to have to compete on branding.

Kraft produced $47.6 billion in revenue in the last trailing 12 months. And it was able to generate $14.6 billion in gross profits, in what is normally a very tight margin industry.

The stock price is up 16% in the past year - a period through which the Standard & Poor's 500 Index has returned 11.75%. This is not as surprising as it sounds. Kraft is one of the most defensive stocks a portfolio manager can purchase, because it has a large line of staple products that are considered demand inelastic.

While rising food costs have hit the bottom line of most business in the sector, Kraft so far has been able to adjust its serving size per container enough to offset some of the new incremental costs. The downsizing of serving sizes allows the company to stay competitive without raising prices significantly.

Kraft pays a stock dividend of 3.7%, which is higher than its trailing annual dividend rate of 2.8%. The dividend increase is not surprising, considering Kraft stock has yielded an average of 3.6% over the last five years.

So let's review why Kraft is a buy in this market:

• It's a stable, profitable business during a period of food inflation.
• The stock has a stable dividend rate over the last five years.
• It has a liquid options market.
• The company can pass on increases in costs.
• It's a solid defensive cornerstone in hard times.

Kraft may not be the most exciting stock on the market, but it offers defensive strength in an uncertain economy. Kraft makes the food that people bring home to eat. It is going to be one of the last companies to feel the real impact of lost income.

Action to Take: Kraft Foods is a great choice for our covered call strategy. It is highly liquid to start with, and it has an options market that will allow us to leverage up the cash flow from the position, in addition to its dividend rate.

Let's purchase our shares at market. The stock is liquid, and while up 5% or so over the S&P 500 in the past year, there is no reason to expect that it is going to get significantly cheaper.

If you are interested in picking up more cash flow from the stock position, look at the February 33 strikes, for some extra income. They are currently bid ask of 27 cents by 28 cents per contract.

Let's look at selling one contract for every 100 shares you want to generate extra income off of in your portfolio.

(**) Special Note of Disclosure: Jack Barnes holds no interest in Kraft Foods Inc.