Shares of The Kraft Heinz Company (NASDAQ:KHC) continue their upward ascent on the heels of another stellar earnings report. The equity is up over 30% since my initial coverage last June, after the announcement of the merger. The original analysis and its numerous outstanding comments can be seen here. The article below will serve as an update to my fair value on the company.
Technical analysis can add to the overall understanding of the future path of an equities share price. While I do not use technical analysis as an absolute, I find it useful in entering into and exiting positions. The chart above is a weekly look at KHC performance since 2014. The huge gap up in March of 2015 is the announcement of the merger with Heinz. My interest in the security began in June when the equity gave back a bit of the run up post the merger announcement. KHC remains locked in an upward ascent with the 50 week moving average serving as downside support during periods of market turbulence.
The combined entity continues to outperform as witnessed by the three gaps up following well-received earnings reports at the end of February, early May and now early August. All three reports were met with a large gap up in share price; a welcome event for the bulls in KHC. The recent move higher, allowed the stock price to tag a new all-time high reversing recent weakness in the sector. Post the Brexit sell-off the consumer durable sector has come under selling pressure as money rotates out into more offensive areas such as biotech and technology companies. While I tend to skew towards growthier names as I am a few years from retirement, the need to have a well-balanced portfolio is tantamount to ride out market volatility. I suspect those who were overweight high growth plays were under enormous strain when the market came under selling pressure earlier this year. A well-balanced portfolio allows one to ride out the storm thus avoiding the temptations to sell at what is usually proven to be a less than opportune prices.
The bear thesis on KHC revolves around anemic top line growth as customers switch to healthier alternatives. The bear case has merit as KHC top line growth remains under pressure due to a large mix of center store items which remain under pressure. In a bow towards a healthier lifestyle, packaged food manufacturers are taking steps to make their products more natural such as KHC recent decision on it iconic Mac and Cheese line.
My bullish thesis on KHC revolves around continued EBITDA growth in a similar fashion to the stellar results posted by Heinz after they were taken private. In this regard, the company continues to perform above initial expectations as witnessed by its EBITDA growth. Barring additional M&A activity, KHC top line growth will continue to grow at a single-digit rate. The key here is the current management's ability to ring out unnecessary costs, thus far the results speak for themselves.
Finbox.io Fair Value
My current fair value for KHC is $94.98 as shown above. The model above utilizes a weighted average cost of capital of 7% with an exit EBITDA multiple of 16.5x EBITDA. I remain very confident in the companies ability to drive higher EBITDA margins; the jury is still out as far as meaningful top line revenue growth in a challenging market.
The stellar management team of KHC views the company as their vehicle to further consolidate the processed food sector. The slide above is taken from the slide deck from the announcement of the merger, neatly summarizes the opportunity for additional M&A activity before the decade ends. I do not expect KHC to make a further move until 2018 at the earliest as the integration of Kraft remains in its infancy. I am highly confident before the decade closes one of the companies shown above, to the right of the combined KHC (Yes, this includes Coca-Cola (NYSE:KO) to the surprise of many) will be consolidated under the KHC corporate umbrella. I am assuming the benign interest rate environment will remain in place greatly enhancing the appeal of further consolidation. A severe back-up in rates would scuttle further M&A activity. I view a significant jump in rates as a low probability event, yet the risk remains.
The Role of the Dividend
The question many may have is why not sell now and lock in a hefty gain of over 30% in a one-year holding period. The answer is the long-term prognosis remains quite favorable with a sizable dividend to tide me over as we wait for the next acquisition. KHC current dividend is 60 cents per share for a current yield of over 2.5%, well above the rates offered by fixed income securities. An excellent opportunity is before us detailed in my report titled "My Top Pick for 2017" available exclusively to subscribers of the Undervalued Gems Investment Service. The yield on the security highlighted in the report is comfortably in the 3% range with excellent growth and income prospects for the next couple of years. Who says you need to take on above-average risks to generate adequate returns. I remain quite comfortable holding shares of KHC while allowing the dividend to reinvest and compound from here.
The shares of KHC continue to outperform the market since the consummation of the merger with Heinz. The next growth leg will come from a meaningful boost to the top line. The industry remains mired in a deflationary cycle that is hampering revenue growth in the food sector. Once the cycle reverses, I suspect KHC fair value will rise substantially above my current fair value target. I would like to thank you for reading, I look forward to your comments.
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Disclosure: I am/we are long KHC.
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.