Kraft Heinz Is A Sell

| About: The Kraft (KHC)

Summary

Low rates are causing buying in dividend stocks.

This buying makes them mostly overvalued.

Kraft Heinz has a PE of 28, so it is one of the overvalued stocks.

It is Janet Yellen's world and we are just living in it. That is the investing landscape currently where central banks are increasingly affecting stock prices. Central bank intervention started when Alan Greenspan reacted to the 1987 crash and has led up to Ben Bernanke and Janet Yellen's quantitative easing and ZIRP policies. We have, for the past few years, been living in a world where bad news is good news because investors are hoping for more central bank expansion. This is what happened last Friday when a 1.2% GDP report caused stocks to actually move higher. This type of performance is unsustainable. Technically every business cycle leads to an eventual recession, but this type of artificial juice being added to the market makes a bigger crash more likely.

When central banks keep interest rate low it tends to cause bubbles. It caused the housing bubble and more recently the fracking bubble as frackers were able to borrow at low rates and drill wells which were only profitable at high oil prices. The high oil prices played a part in the bubble, but the Fed helped it along.

The purpose of this introduction is to bring about the point that bubbles are probably more prominent than ever before because interest rates around the world are near zero or negative. Easy access to capital is like if a young kid whose parents were rich gave him a million dollars to start whatever business he wanted. He would probably lose the money quickly. There will always be businesses who need capital and use it responsibly, but when anyone can get access to it, there is inevitably a misallocation of resources.

The current bubble in treasury bonds isn't as tough to spot as the others since central banks are directly inflating the bubble by buying them. This has caused investors to move up the risk curve. Pension funds cannot fulfill their obligations by earning 1.50% on the 10 year bond yield. In theory they could sell them for a profit, but typically they hold the bonds to maturity. Stocks has been the only place to put money to work regardless of valuation. Earnings are about to be down 5 quarters in a row, but investors need to buy stocks to earn a return as yields have been low for a few years now and stocks have been stable.

The best place for investors who want to buy stocks as a bond replacement are stable dividend paying companies. These stocks have been the place to be even as their fundamentals sometimes aren't strong. There is a bit of a feeling some investors may have that in some cases the worse a company does, the more investors bid the stock higher. This certainly has been the case with consumer staples stocks. Stocks like Campbell Soup (NYSE:CPB), General Mills (NYSE:GIS), and Kraft Heinz (NASDAQ:KHC) are seeing some of their brands lose out to more innovative and healthier options causing slowing sales growth. Simultaneously investors are buying their stocks for dividends and putting them at all-time highs.

In this article highlighting Kraft Heinz we have another steady company with little growth, a decent dividend, and a sky high PE. Kraft Heinz only had 1.5% sales growth last quarter. The next earnings report comes out later this week, but I'm expecting similar results. Management may say it's focused on innovation, but I am worried they are only focused on cost cutting because of the recent merger between Kraft and Heinz.

When comparing the situation to the Lorillard and Reynolds merger, this one comes out worse because the tobacco industry is stable as the brands are consistent and customers are loyal. In this merger, you are combining behemoth brands together, some of which are experiencing declines. In the quarter, the management team called out ready to drink beverages, bacon, and frozen nutritional meals as laggards. It's going to be difficult to focus on improving small cogs in a giant machine of a packaged goods company, so I wouldn't expect the company to have any incremental improvements other than it paying down debt to de-lever the balance sheet and it cutting costs because of synergies from the merger.

This is not to say that Kraft Heinz is a bad business. It is simply a bad stock at this current valuation given the circumstances in play. The stock trades at 39.25 times 2015 earnings and 28 times 2016 estimates. There isn't going to be a new innovation that will cause the firm to grow into those valuations. The stock is simply expensive and will stay that way until a drop in the share price occurs.

As I have said in my other posts on consumer staples stocks, there isn't going to be a change in the stock price because of over valuation. While that may be the case, I believe the returns over the long-run are limited because of these prices. As a long term investor, using valuation as a guiding factor to buy and sell stocks inherently recognizes the fact that you aren't going to be timing the market perfectly. Kraft Heinz stock could probably move 10% higher over the next few months without a problem if the central banks are able to maintain the status quo.

Conclusion

Stocks are being manipulated by central bank policies. Just because consumer staples stocks have a low beta and a high dividend, doesn't make them immune from excessive valuations. The entire sector is red hot even as most firms like Kraft Heinz experience almost no sales growth. Because the merger has made Kraft Heinz into such a behemoth, I don't see it being able to improve its established brands to meet the needs of the more health conscious consumer.

Therefore, the company will rely on cost cutting to grow earnings. This has a limit because there is only a certain amount that can be cut. All of these negatives being said, the stock isn't going to correct because of them. The only way this stock will come back down to Earth, is if the central bank policies cause dividend paying stocks to become unloved. This would happen if the bond bubble bursts.

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. I have no business relationship with any company whose stock is mentioned in this article.

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