HRL - Kraft Heinz Stock Has Stalled And Things Look Unlikely To Change

2023-04-19 13:46:44 ET

Summary

• The Kraft Heinz Company has been trading in a narrow range for several years now.
• Despite a good dividend, the company's growth prospects seem dim.
• For The Kraft Heinz Company to grow, we believe investments must be made in new products.

An Unlikely Casualty

Mega-trends and their effects, like globalization, move slowly until they're upon us, and then they appear so obvious that its incredible anyone could have missed it. But in the current environment of high inflation and a possibly beginning period of de-globalization, we can look back at the old times and wonder if any of the companies which lost out from globalization may make a comeback.

Americans, for example, experienced a long and pronounced benefit from globalization--a steady decline in the price of basic foodstuffs relative to incomes. This led to a massive change in the way that Americans ate, and shopped. Tastes moved up the scale en masse over the years, leaving many former American food staple companies to grapple with a new reality.

The Kraft Heinz Company ( KHC ) was one of those corporations. In this article, we'll examine where Kraft Heinz is currently, and if their fortunes are likely to change in the near future.

Background

Kraft Heinz has many household brands in its stable of foods and beverages, from Kool-Aid and Capri Sun, to Velveeta and Maxwell House (not to mention the eponymous ketchup). The company has a long list of brands that occupy the lower end of the cost scale and are overall struggling to maintain market share.

Despite a solid Q4 2022 where sales jumped 10% for the quarter year over year, revenues have largely been flat since 2017. Operating income has also remained steady although margins have been compressed somewhat as inflation has set in.

The woes of The Kraft Heinz Company in the stock market over the past several years are also quite well known.

Since 2017, Kraft has delivered a total return of negative 42%, while the broader S&P 500 (SP500) has delivered almost 80% to the good. The return excluding dividends is, as you would expect, significantly worse. On a price appreciation basis alone, Kraft has seen a decline of 55% over the same period.

Based on these figures, if an investor came to Kraft Heinz with only this knowledge, they could be forgiven for being shocked to learn that Warren Buffett's Berkshire Hathaway Inc. (BRK.A) (BRK.B) has an ownership stake of over 30% in the company. (More on that later.)

Since mid-2019, then, CEO Miguel Patricio has been working to turn the ship around at Kraft Heinz, with limited results (though, to be fair, shares have rallied about 20% since he came into the picture as CEO).

Looking Ahead

For a company that has multiple bread-and-butter pantry staples in its arsenal, one thing that seems conspicuously absent from The Kraft Heinz Company's conference calls and its filings is work on developing new products that could meaningfully grow sales.

For example, against net sales of $26.4 billion in 2022, Kraft Heinz spent only $127 million on research and development in 2022. We'll note that competitors in the space (such as Mondelez ( MDLZ ) and Hormel ( HRL )) spend quite small amounts themselves on research and development, but those two companies haven't found themselves struggling in the same manner as Kraft Heinz.

Instead, the company looks to find new efficiencies within the business as a way to improve the bottom line. To this end, management noted that the company had executed on $400 million worth of savings for the company in 2022.

A penny saved is a penny earned, of course, but it doesn't necessarily translate into sales.

Analyst estimates reflect this sentiment, as revenue expectations peg Kraft Heinz growing its top line at a low-single digits rate for the next three years.

A simple way to increase revenue is to raise prices (which the company has done), but it seems that even this strategy has been put on pause. Patricio stated on the conference call that:

"[f]rom a pricing perspective, 99% of all needed pricing has already been announced for 2023. As we look to the rest of the year, we have no current plan to announce new pricing in North America, Europe, Latin America and most of Asia."

Valuation & Dividend

On a forward EV/EBITDA basis, Kraft has traded in a relatively narrow valuation range for several years. There was a time when the stock commanded a much higher multiple, but the re-rating its valuation has undergone in the last five years seems to be fairly sticky.

On a ten-year basis, Kraft's average EV/EBITDA is 13x, which is a bit above the current, steady valuation of roughly 11x forward estimates. For as long as management continues to prioritize cost cutting over innovation, we expect this to remain the typical state of affairs.

Kraft's dividend (which we suspect is a large part of the reason Buffett continues to hang on) is at the time of this writing a respectable 4.05%, which at $0.40 per share has cost the company roughly $1.9 billion each year since 2019.

With margins being squeezed in an inflationary environment, 2022 was the only year since 2019 that common dividends exceeded free cash flow. However, with the company's new pricing in effect we don't believe this situation will persist in the future.

The Bottom Line

With a low market beta and a solid dividend, The Kraft Heinz Company is certain to hold appeal for certain investors. However, we believe that the company's business focus is unlikely to bear fruit in the long term (you can't cut costs forever), and that investments must be made in new products for the company to really thrive.

Therefore, for now we must pass on The Kraft Heinz Company, and we believe investors looking for growth (both revenue and market share) are best served looking elsewhere.

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