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Should You Buy Kraft Heinz for Its 6% Dividend Yield?

By Leo Sun - Updated Apr 15, 2019 at 9:00PM

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Is the packaged foods titan a cheap income investment, or a high yield trap?

Check out the latest Kraft Heinz earnings call transcript.

2018 was a rough year for Kraft Heinz (KHC 0.66%), the packaged foods giant created by the merger of Kraft Foods and Heinz in 2015. Its stock plunged nearly 40% on concerns about its weak organic sales growth and an ongoing loss of consumers, who were pivoting toward healthier and organic brands.

That pain was exacerbated by rising interest rates, which convinced some investors to dump their dividend stocks for bonds, and the declines across the broader markets. Yet the sell-off reduced Kraft Heinz's forward P/E to 12, and boosted its forward dividend yield to 5.8% -- which makes it look like an undervalued income stock.

The Oscar Mayer Wienermobile.

Image source: Kraft Heinz.

So should you buy Kraft Heinz as a long-term income play at these prices? Let's examine its core business and growth rates to find out.

Understanding Kraft Heinz's core business

Private equity firm 3G Capital acquired and privatized Heinz with Berkshire Hathaway in 2013. Two years later, the two companies merged Heinz with the publicly traded Kraft Foods to create Kraft Heinz. The company now sells over 200 packaged food brands, including Kraft, Heinz, Oscar Mayer, Planters, Kool-Aid, Jell-O, Philadelphia, Velveeta, and Grey Poupon.

However, consumer interest in those classic brands continued to wane, and Kraft Heinz's management -- which was appointed by 3G -- focused heavily on cutting costs instead of investing cash into the expansion of its portfolio or launching new marketing campaigns. As a result, Kraft Heinz's organic sales flatlined, and only returned to firmly positive territory last quarter:

 

Q3 2017

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Organic sales

0.3%

(0.6%)

(1.5%)

(0.4%)

2.6%

Net sales

0.7%

0.3%

(0.3%)

0.7%

1.6%

YOY growth. Source: Kraft Heinz quarterly reports.

That rebound looks encouraging, but it was primarily driven by lower prices. Kraft Heinz's pricing -- which steadily rose in previous quarters -- contracted 0.9 percentage points annually during the third quarter, mostly due to higher promotions and cost inflation, and its margins contracted across the board:

Metric

Q3 2017

Q3 2018

Gross margin

35.1%

33%

Operating margin

24.5%

16.8%

Adjusted EBITDA margin

30.1%

25.3%

Source: Kraft Heinz quarterly reports.

On the bright side, Kraft Heinz expects its organic sales to stay positive in the fourth quarter, and for its adjusted EBITDA margin to start improving as it finds a "balance between cost inflation and savings," according to CFO David Knopf during last quarter's conference call.

Kraft Heinz has also been more aggressive with acquisitions, like its recent purchases of Primal Nutrition, a maker of paleo-friendly food products, and the organic coffee maker Ethical Bean. This indicates that it's willing to diversify its portfolio with smaller but higher-growth brands -- which mirrors General Mills' (GIS 6.35%) takeover of premium pet food maker Blue Buffalo and the organic food maker Annie's.

A grocery cart in a supermarket aisle.

Image source: Getty Images.

Analysts expect Kraft Heinz's revenue to stay flat this year and rise just 1% next year. Its earnings are expected to grow 2% this year and 3% next year. Those growth rates look anemic, but they aren't as disastrous as the stock's decline suggests. Its rival General Mills is expected to grow its revenue and earnings by 1% and 6%, respectively, next year.

How sustainable is Kraft Heinz's dividend?

Kraft Heinz raised its dividend every year since the merger. Over the past 12 months, it spent 30% of its earnings on its dividend, lower than General Mills' payout ratio of 57%.

Kraft's dividend payments exceeded 100% of its free cash flow (FCF) during that period, but its FCF was mainly weighed down by cyclical issues like bigger commercial investments, supply chain challenges, and cost inflation, which should wane over the long term. General Mills only spent 57% of its FCF on its dividends over the past 12 months, although it pays a slightly lower forward yield of 5%.

Is Kraft Heinz a good dividend stock?

I think Kraft Heinz is approaching an inflection point, and its high yield should limit the stock's downside. Its recent acquisitions can generate fresh sales growth, and balancing out its pricing and inflation issues should stabilize its margins. It won't be a smooth ride, but investors who buy Kraft Heinz for its dividend today could be well-rewarded over the long term.

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Stocks Mentioned

Kraft Heinz Intermediate Corporation II Stock Quote
Kraft Heinz Intermediate Corporation II
KHC
$37.98 (0.66%) $0.25
General Mills, Inc. Stock Quote
General Mills, Inc.
GIS
$74.72 (6.35%) $4.46

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