Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
When Goldman Sachs downgraded Kraft Heinz Company (NASDAQ:KHC) stock on Wednesday, negative sentiment from one of the biggest names on Wall Street helped to shave a nickel off of Kraft Heinz's stock price. But today Kraft shares are getting a vote of confidence.
For this, you can thank the friendly bankers at Piper Jaffray.
Jaffray pipes up
As reported on StreetInsider.com (requires subscription), investment banker Piper Jaffray has upgraded shares of Kraft Heinz stock this morning, assigning the stock an overweight rating (despite how it sounds, that's a compliment) and a $90 price target.
Now mind you, Piper Jaffray's new price target is $2 less than what it had Kraft stock pegged at previously. But that's understandable -- Kraft stock has been getting cheaper all year, with its share price falling nearly 20% since highs hit in mid-February. Although Piper's new price target is a bit lower than it once was, it promises new investors in Kraft Heinz stock about a 15% profit from today's prices. Throw in a beefy 3.2% dividend yield, and profits could potentially be as big as 18%.
Misery loves company
What is it that has Piper feeling so positive about Kraft Heinz today? Simply this: The "recent pull back" in prices on packaged food stocks like Kraft Heinz hasn't been limited to just Kraft Heinz. It's hit a lot of the companies' peers in the food aisle, too -- and hit some of them even harder than Kraft Heinz.
In Wednesday's downgrade, for example, Goldman Sachs highlighted J.M. Smucker (NYSE:SJM) and General Mills (NYSE:GIS) as two other companies in the packaged foods space that it likes even less than Kraft Heinz (Goldman downgraded Kraft to neutral, but it has sell ratings on both Smucker and General Mills).
It's in the even worse fortunes of its packaged food peers, says Piper Jaffray, that Kraft Heinz may find opportunity. By scanning the stock tickers of its rivals, Piper believes Kraft may succeed in "identifying and executing highly accretive deals" to consolidate the food industry even further, and to accelerate its own sales and earnings growth in the process.
While it's true that Kraft Heinz stock is down 10% over the past year, both Smucker and General Mills are down even more (20% and 16%, respectively). Mind you, Piper Jaffray is not saying that Kraft will buy either of these other companies, or even that it should. What the analyst is pointing out, though, is that Kraft isn't the only packaged foods stock on the rocks today, and that by taking advantage of other companies' dire financial straits, it may help to improve its own fortunes.
As StreetInsider puts it: "[C]heaper target valuations in the space increase optionality for management to generate double digit accretion."
Final thought: Valuing Kraft Heinz
And to be perfectly honest, Kraft Heinz could probably use some accretion right about now. At its current valuation of more than 25 times earnings, Kraft stock may be less expensive than it once was, but for a stock that's still pegged for less than a 9% earnings growth rate, it's still far from cheap.
To justify this kind of valuation under a traditional PEG analysis approach to investing, Kraft Heinz stock really needs to get its growth rate up north of 20% per annum -- and ideally, get it close to 25%. Problem is, with $26.2 billion in annual revenue, and $3.8 billion in annual profits, it's going to take a pretty big acquisition for Kraft to get anywhere close to that kind of growth, and such an acquisition won't come cheap.
Referring back to the examples up above, buying either Smucker ($7.3 billion in annual sales) or General Mills ($15.5 billion) would certainly do the trick. Then again, at P/E ratios of 22.2 and 18.6, respectively, both of these stocks look nearly as expensive as Kraft itself.
If you ask me, the real risk to Kraft Heinz investors today is that the company will take Piper Jaffray's advice and buy one of its big, slightly less-expensive-than-itself rivals, and end up overpaying for growth.