KHC - The Kraft Heinz Company Keeps Looking Like A Great Turnaround Opportunity

2023-08-22 13:24:54 ET

Summary

• Kraft Heinz reported better margins, international growth, and increased operating and net income in the first half of 2023.
• The company's growth strategy in emerging markets is showing promising results, with double-digit growth and a focus on building distribution capacity and infrastructure.
• Kraft Heinz is close to achieving its optimal leverage level, which will allow for potential opportunities in M&A, dividend increases, or share buybacks.

The Kraft Heinz Company ( KHC ) reported half-year numbers with the company reporting better margins, attractive increases in its international operations, the achievement of its optimal leverage, and significant increases in its operating and net income. In this article, I will review the company's financial performance, its growth strategy, and financial leverage evolution. With this in mind, I reaffirm my strong buy rating for the company as I believe investors can take advantage of a nice dividend yield at approx. 4.75% while at the same time having the opportunity of a substantial upside on the price per share. Let’s take a look at the financial performance!

First Half 2023 Financial Performance

During the first half of 2023, KHC reported a revenue increase of 4.9% compared to the same period last year. This increase was mainly due to price realization of 12.8% while volume saw a decrease of 6.2%. It is important to note here that most of the increase came from the international segment of the business which saw its revenues increase by 9.7% from $3 billion to $3.25 billion. As will be discussed in detail later in the article, an important part of the international segment increase is coming from the emerging markets and food service globally, where the company is putting in place an effective growth strategy.

Moving to the Gross Margin, the company was able to improve its performance by 337 basis points which allowed management to make double-digit investments in marketing, R&D, and technology. The company increased R&D spend by 10% versus the prior year, and marketing investment increased by 23%. These are great improvements as management is finding ways to increase investments in key parts of the business with capital from inside the company and not external sources.

Despite these enhanced investments in marketing, R&D, and technology, KHC was able to produce a 58% increase in operating income from $1.7 billion during 1H-22 to $2.6 billion in 1H-23. Furthermore, the company achieved an operating income margin of 20%. To end, it should be mentioned that after various years of reporting goodwill and intangible write-downs, the company finally had a clean period with no write-downs. Additionally, as the company keeps decreasing its debt levels, its interest expense keeps decreasing. This combination helped the company boost its net income to $1.8 billion and post a net income margin of 13.9%.

Emerging Markets Growth Strategy

The company continues to deliver double-digit growth in Emerging Markets. In the second quarter, Organic Net Sales grew 11%. This is despite one-time impacts that reduced year-over-year growth. The largest of these were delivery delays in Brazil, which impacted customer replenishment orders. As such management expects Emerging Markets growth to accelerate after these one-time impacts. Important to note here that Emerging Markets represent ~10.7% of consolidated Q2 2023 total Company Organic Net Sales. The company is having success in the Emerging Markets, thanks to its proven Go to Market strategy.

The Go to Market strategy in the Emerging Markets has three phases and has been tested and executed in Indonesia and Brazil. The first phase is building the distribution capacity using partners and importing models. Within this phase, we see countries with sizeable populations such as Saudi Arabia and Colombia. In the second phase, the company looks to build a strong infrastructure in the countries with warehouses, sales teams, and merchandising. We can see here that KHC is already in this phase in countries with populations of +100 million with countries such as Egypt and Mexico. The final phase has the full structure, where KHC has in place all of the items from phase 1 and 2 and additionally it has manufacturing and warehousing scalability while at the same time strong sales and marketing teams.

To have a deeper understanding of this growth strategy in Emerging Markets, let's take a look at Brazil where the three phases have been fully implemented and where Kraft Heinz is in full throttle to take advantage of various opportunities. Since 2018, KHC has seen a 43% distribution growth, with Heinz seeing a coverage growth of 1.8x. In Brazil, the company has increased its sales by 2.4x since 2018 driving organic sales of 17% on a CAGR basis and achieving a 29% market share.

This model not only helps KHC to expand its brands, but it also helps the company have a better overview of M&A opportunities as it can see which domestic brands can be rapidly scalable. A good example of this is the acquisitions of Hemmer and BR Spices.

Financial Leverage Evolution

Kraft Heinz is very close to achieving its optimal leverage level of 3x. As the company continues to strengthen its balance sheet and reduce debt, it is now on a sustainable path of keeping its leverage level within 3x. This in turn will allow the company to look at different opportunities on how to deploy capital. These opportunities could lead to more and bigger M&A scenarios, an increase in dividends, or the deployment of a share buyback program. Given that the reduction of debt will no longer be a priority, we could see the company take a more aggressive stance to return capital to its shareholders or look at inorganic growth through M&A opportunities.

Conclusion

The Kraft Heinz Company ((KHC)) has demonstrated a strong financial performance in the first half of 2023, with significant improvements in margins, international operations, operating income, and net income. The revenue increase of 4.9% was mainly driven by the international segment, particularly in emerging markets where the company has implemented an effective three-phase growth strategy. This strategy has been successfully executed in countries like Brazil, leading to substantial growth in distribution and market share. We can expect the company to continue to implement this strategy in other countries.

Furthermore, the company's financial leverage evolution is nearing its optimal level, allowing for potential opportunities in M&A, dividend increases, or share buybacks. With an attractive dividend yield of approximately 4.75%, and the potential for substantial upside in the price per share, investors should take note of KHC.

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