Kraft Heinz: The Turnaround Is Taking Shape
Summary
- The Kraft Heinz Company is showing signs of stabilization.
- The share price is widely undervalued.
- The stock is very likely to benefit from the COVID-19 crisis for longer than expected.
- From here, I believe a turnaround is already taking shape.
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Image source: supermarketnews.co.nz
Dividend: $1.60
Dividend Yield: 5.16% (as of writing)
All-time Highs: $97.77
Current Stock Price: $29.95 (as of writing)
Investment Thesis:
Since the merger between Kraft Foods and H. J. Heinz, The Kraft Heinz Company (NASDAQ:KHC) has faced a series of headwinds that have plunged the company into a spiral of bad news that has depressed the share price to very low levels. At the moment, the stock trades at an approximate 70% discount from its highs in February 2017.
The high amount of debt the company is currently carrying, together with a consumer shift towards more organic, healthier foods, and a cost-cutting strategy whose results have turned out to be disastrous have put the company between a rock and a hard place and questioned the credibility of the management team.
However, the company is giving signs of stabilization when it comes to revenue, Free Cash Flows and debt reduction capacity. From here, the beginning of a turnaround is most likely, and the company has the capacity and opportunity to turn things around. The COVID-19 crisis will play a key role in this recovery process, and the dividend is well covered by the Free Cash Flow, but don’t expect any increase until 2022.
I strongly believe that, from here, a turnaround is starting to be seen and will continue in the long run. The dividend at 5.16% is safe and offers a return that will beat inflation for the years to come, but a dividend increase will have to wait until at least 2022.
Brief Overview of the Company:
The Kraft Heinz Company is one of the biggest food conglomerates around the world. It operates in more than 200 countries and territories, selling Fast Moving Consumer Goods. Founded in 2015, it is the result of the merger between Kraft Foods (founded in 1903) and H. J. Heinz (founded in 1869), making it a company with 151 years of existence.
The company sells beloved brands such as Heinz dressings, Kraft dressings, Kraft Macaroni & Cheese, Oscar Mayer and Philadelphia, and also owns a huge portfolio of local brands all around the world.
Product innovation and acquisitions:
Image source: Abasto.
The Kraft Heinz Company is constantly diversifying its portfolio through innovation and acquisitions.
Recently, it has launched a new series of products under the brand Devour that includes a set of Frozen Meals, Frozen Sandwiches, Frozen Pizzas and Instant Bowls. Also, the company teamed up with Diageo (DEO) to release a new series of Coffee products under the brand of Baileys, making a great opportunity for growth in the coffee and non-alcoholic beverage segments. Kraft Heinz also collaborated with Oprah Winfrey to launch O, That’s Good! Frozen Pizza.
Also, it is updating its current products in order to adapt to the current consumer trends. The best example is its new product Heinz Ketchup with a blend of veggies, which has 25% of added vegetables and 25% less sugar than the original Heinz Ketchup. Another example is the launch of new flavors for the Planters brand early this year.
Furthermore, Kraft Heinz is trying new mixtures within its current portfolio of brands, introducing new products like its Heinz Mayoracha, Heinz Mayochup, Heinz Mayocue and Heinz Mayomust. Although I don't believe these mixtures will move the needle, some of their launches are very promising, like Heinz Ketchup with a blend of veggies or Baileys Coffee.
In September 2018, Kraft Heinz completed the acquisition of Ethical Bean, a Canadian, fair-trade organic coffee company founded in 2003. In January 2019, the company also completed the acquisition of Primal Kitchen, a food company with the aim of creating food products that respond to new trends in diets, in a deal valued at $200 million. Primal Kitchen is very innovative and its products have a huge potential, especially for the U.S market. As these are products difficult to find in common supermarkets and grocery stores, this represents a huge opportunity to boost its online retail sales.
Soon after the acquisition of Primal Kitchen, the company launched a new set of healthy Frozen Bowls & Skillets under the Primal Kitchen brand, showing its commitment to bet on this new division of the company.
The global portfolio of brands is bigger than most investors think:
Image source: America-retail
While the US accounts for about 70% of total earnings, the portfolio of brands owned by Kraft Heinz includes many local brands and products all around the world. It owns Pudliszki in Poland, Gevalia in Sweden, Orlando in Spain, ABC in Indonesia, Heinz Baby in Canada, HP in the United Kingdom, Quero in Brazil, PurePet in New Zealand, Bénédicta in France, Amoy in China and Plasmon in Italy, among others.
Source: 10-K Filing
This represents a big opportunity for growth internationally, and the new CEO, Miguel Patricio, is a good candidate to explore these opportunities. As a global chief marketing officer in AB InBev (BUD), Miguel Patricio managed to expand the company’s beer business in China and other Asia-Pacific countries. Soon after joining Kraft Heinz as the new CEO, he suggested that there was a great opportunity to do the same at Kraft Heinz.
But let me share with you another experience from my past that I think we can adapt here at Kraft Heinz. I ran our business in Asia, and China has been the best story of organic growth for ABI. (Miguel Patricio).
Source: Q1 and Q2 2019 Earnings Call
This global portfolio is also strategically located in many countries, and gives Kraft Heinz a perfect weapon against one of the most feared threats for CPG companies: Store brands. Store brands are made by national brands, small manufacturers specialized in store brands or big retailers that own factories. Big CPGs usually refuse to make store brands, because that can cannibalize their earnings by making people switch to private label products produced by their favorite brand's company. But owning different brands distributed worldwide that basically produce the same under different brand names opens a big opportunity when it comes to exports of store brands. I can perfectly imagine Kraft Heinz exporting Orlando Ketchup, which is a local Spanish ketchup brand, to Poland. In the same way, I can see Pudliszki ketchup (owned by Kraft Heinz too) exporting its ketchup to Spain under a store brand name for a big retailer. Although it is difficult to know whether a company makes store brands because of the secretive nature of this kind of deals, we can be sure Kraft Heinz has the opportunity to make these deals work without hurting their own sales.
Q1 2020 Results:
The Q1 ’20 results saw a 3.32% increase in revenue YoY from $5.96 billion in Q1 ’19 to $6.16 billion in Q1 ’20, while Adjusted EBITDA declined 1.1% YoY to $1.41 billion, although the EBITDA Margin improved slightly from 13.92% last quarter vs. 17.77% this quarter. These numbers show that the company is showing a decent stabilization process, which suggests a turnaround could be already happening.
Net sales saw an organic growth of 6.4% YoY, partly as a consequence of people stockpiling their products given the threat of COVID-19, especially in March, when the pandemic threat was so evident.
The company’s Free Cash Flow stood at $81M in the first quarter. Although it seems a low figure, it is so because at the end of the quarter there was a large increase in demand, which produced an increase in receivables and lower inventories.
Dividend:
The company is committed to maintaining its dividend while reducing its debt.
Recall that we set three priorities for 2020: to establish a strong base of sales and earnings; to rebuild underlying business momentum; and continue to reduce debt while maintaining our current dividend. All these priorities are on track, even as we adapt to the new challenges. (Paulo Basilio).
Source: Q1 2020 Earnings Call
Source: YCharts
If we look at the chart above, we can see that the dividend is well covered by the Free Cash Flow. That’s in part because of the dividend cut of 36% that took place in early 2019, but also because of a recent increase in Free Cash Flow.
These figures give Kraft Heinz enough margin to safely pay the dividend while reducing its debt, which is the commitment of the current management, by far more than $600M a year. Currently, its Long-Term Debt amounts to $32.78B, generating an interest expense of $1.34B annually, which is too high. Paying down debt would significantly improve the balance sheet of the company, allowing for more room for growth thanks to a reduction in interest expenses, which would translate into lower payout ratios and, subsequently, room for dividend growth.
However, dividend increases should have to wait past 2021 if the company is that committed to pay down its outstanding debt, although their juicy 5.16% yield should make up for it.
Key Risks to Consider:
We should not forget that Kraft Heinz' outstanding long-term debt is too high at $32.78B, generating $1.34B in interest expenses annually. While the future of the company relies on its capacity to pay down debt, I believe its Free Cash Flow covers the dividend and still leaves a good amount of resources to pay it down.
In recent years, we have seen a significant change in consumer trends towards healthier, organic, less processed food products. Kraft Heinz has been working on it through acquisitions of brands such as Primal Kitchen, and the launch of healthier versions of its current brands, like Heinz ketchup with a blend of veggies. The changes in the company have taken place too slowly, leading to declining revenues. Nevertheless, the coronavirus crisis will mean a return to packaged foods for many families, since they are cheaper than the more organic options and generally have longer expiration dates. This will give Kraft Heinz time to improve its balance sheet in the short to medium term, allowing it to reduce its debt, invest in R&D and acquire brands that are better adapted to new trends.
- When we invest in a Consumer Packaged Goods Company, we can never forget the eternal competition between store brands and national brands. As we discussed in this article, Kraft Heinz has an international portfolio of local brands strategically located that makes possible the export and import of its products between countries, making deals with supermarket chains to sell its products under its private label without cannibalizing the benefits of its main products.
- In July 2020, McDonald's (MCD) will move from Kraft Heinz to Keurig Dr Pepper (KDP) for the supply of coffee for its McCafé division. The end of the partnership will likely hurt Kraft Heinz' earnings, but I believe the change in consumer trends due to the pandemic crisis will likely exceed the losses significantly.
Conclusions:
Q1 ’20 was a good quarter for Kraft Heinz. It showed that it is well-prepared to benefit from the COVID-19 crisis' consequences in consumer behaviors, both in the short and medium term. The company is starting to show stabilization when it comes to revenues and Free Cash Flow, and a very respectable organic growth of 6.4% YoY.
Currently, the Free Cash Flow vastly covers the dividend and allows the company to pay down more than $600M of its outstanding debt annually. Since its debt is too high at $32.78B, I don’t expect any dividend increase anytime soon, not even in 2021. However, the dividend yield is pretty decent at the current rate of 5.16% and looks very safe.
Since only the beginning of the COVID-19 crisis is reflected in the first quarter, I strongly believe the Q2 ’20 quarter will be even better than Q1 ’20, and we may see a stabilization by Q3 ’20 and beyond.
Given the headwinds the company has faced during the last 3 years, the price is very undervalued at about 70% discount from its all-time highs in February 2017. Trading at $31.03 as of writing, The Kraft Heinz Company is well-prepared to dodge the recent headwinds it has faced and move along while reducing its high debt, making its current dividend a safe one. Don't expect a raise until 2022, just buy Kraft Heinz for its 5.16% dividend and forget it.
This article was written by
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (21)
1) Jorge has publicly stated they were used to the safety of brands, but that the world has changed.
2) The debt load is insane
3) You cannot extrapolate the recent revenue boost into perpetuity. This has nothing to do with their "strategy" and was simply driven by Covid-19.
4) Their long-term lunch is still being eaten by private label / smaller brands. This is NOT a growing space.
5) Please plot marketing/R&D cost as % of revenue vs peers. May the investing force be with you, you will need it.
- KHC has been a serial disappointer, and senior management, esp. at Board (and ownership) level has been pretty constant, even to Mr. Buffett's frustration;
- your article has not covered the biggest competitors for rack space worldwide, i.e. Unilever, Nestlé and Mondelez, and everytime I visit a supermarket, I come away thinking why are KHC's products almost always stacked away somewhere, and no excitement seems to emanate from them, while the giants named above seem to continue to find their exciting 'niche', in the most visible part of the supermarket, be it in normal counters or the refrigerated sections. I dread KHC's products going into the frozen foods fridges, as they will likely remain frozen there!;
- so many have tried and failed in coffee, I worry KHC will not break into the shelf stacking order that is controlled by Nestlé, and countless local and in-store brands;
- as COVID effects wane gradually, is there a risk KHC's businesses go back to a lower new normal, worldwide?
- I'd always wondered who the bondholders are, it would not surprise me if 3G management insiders are themselves in it, so this business could just be a way to 'milk' the poor, ageing beast, to the shareholders' peril.
