Kraft Heinz: An Attractive Long-Term Investment

| About: The Kraft (KHC)

Summary

Company plans to reduce its costs by $1.5 billion annually by the end of 2017.

Stock offers a solid dividend yield of 2.7%.

Stock is currently trading at a forward P/E of 22x, versus its peers average forward P/E of 21x.

Kraft Heinz Company (NASDAQ:KHC) has a strong product portfolio and holds a dominant market position in different product categories. The company has been working on product innovation and expanding its market presence to support its sales growth. However, in the near-term, the company's earnings growth will be fueled by its aggressive cost saving measures. The company has an attractive margin expansion story, and the management can announce incremental cost savings, which will augur well for the stock valuation. The stock is trading at a forward P/E of 22x, versus its peers average forward P/E of 21x.

Growth Catalysts

In the recent past, packaged food companies in the U.S., including KHC, have been experiencing weak sales volume growth mainly because of a shift in consumer eating preferences. The company's aggressive product innovation efforts will support its sales volume in the challenging industry conditions; sales for the company are expected to grow in the low single digits in the upcoming years. Also, the company's restructuring measures include making an investment in the supply chain to produce fresher products, according to consumer preferences, in the refrigerated category. The optimization of supply chain and improving freshness of refrigerated products will augur well for its market share. Moreover, in the upcoming quarters, KHC is likely to increase its focus on marketing and advertisement activities to back its product innovation and brand building efforts, which will lead to better sales volume in the long-term.

Its cost reduction efforts will mainly drive the company's growth in the near-term. The company plans to improve its cost structure and expects to generate cost savings of $1.5 billion annually by the end of 2017. The cost savings are likely to be generated through workforce reduction, factory closures and modernization of manufacturing facilities. A portion of the cost savings will be reinvested to support product innovation and brand building initiatives. Consistent with its cost savings efforts, the company generated $225 million in cost savings in 1Q16. As the company has been consistently working to reduce costs, it can announce incremental cost savings in the upcoming quarters, which will positively affect the stock valuation.

As the sales volume growth stays challenged, cost reduction remains key earnings growth driver. I am not saying that cost cuts offer a long-term solution for shareholder value creation. I am just making a point that KHC has been operating with excess manufacturing capacity and operational inefficiencies for too long, which are not justified. The cost savings are expected to boost profit margins by 600bps to 700bps.

Moreover, the company can opt for another acquisition once it pays down debt used for Kraft Foods acquisition. The company can target to acquire major food companies with the strong product portfolio and inefficient cost structure. Potential targets for KHC acquisition includes General Mills (NYSE:GIS), Mondelez (NASDAQ:MDLZ) and Kellogg (NYSE:K). Moreover, the company will want to acquire a company which has significant international market footprint, which will help KHC to diversify its sales base, as currently almost 70% of its sales are generated from the U.S. market.

Valuation and Dividends

The stock is currently trading at a forward P/E of 22x, ahead of its peers average forward P/E of 21x. I think, the stock's premium valuation is justified given its attractive margin expansion story. Moreover, if the company shows even a modest sales growth improvement in the future years, it will positively affect the stock valuation. However, if the company fails to deliver on its planned cost savings, the stock valuation will contract as the anticipated cost savings and margin expansion are fully priced in. Also, the stock offers a solid dividend yield of 2.7%, which makes it a good investment prospect for long-term income investors.

Summation

The company's product innovation and brand building efforts will help to address the industry challenges and augur well for the sales volume. In the near-future, the company's sales growth will be mainly driven by cost reduction and margin expansion. The company plans to reduce its costs by $1.5 billion annually by the end of 2017. If the company announces incremental cost savings, it will positively affect the stock valuation. The stock is currently trading at a forward P/E of 22x, versus its peers average forward P/E of 21x. The stock will continue to trade at premium valuation given its aggressive cost reduction efforts. Moreover, the stock offers a solid dividend yield of 2.7%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.