Last week was a bad time to have the "Kraft" name. On Friday, Feb. 22, the owner of the National Football League's New England Patriots, Robert Kraft, was charged with soliciting sex in Florida, while food giant Kraft Heinz (NASDAQ:KHC), a company rich with history and household food brands, lost more than a quarter of its value ($15 billion) following the release of its fourth-quarter and full-year operating results.
While Robert Kraft's issues are limited to just him, his family, and possibly his organization, Kraft Heinz's problems extend much further and have wiped out billions of dollars in a very short amount of time.
Who cut the cheese?
By now, you're probably familiar with the trifecta of failures that Kraft Heinz brought to the table last week. If not, here's a brief recap. The company:
- Disclosed a writedown of $15.4 billion (not a typo) in intangible assets tied to its Kraft and Oscar Mayer brands, pushing its fourth-quarter loss on a non-adjusted basis to more than $10 a share.
- Announced a quarterly dividend of $0.40 per share, which represents a 36% reduction from the $0.625 quarterly dividend Kraft Heinz had been paying. The payout cut is designed to save the company about $1 billion a year in order to help reduce long-term debt of $30.9 billion.
- Announced that it had received a subpoena from the Securities and Exchange Commission regarding the company's accounting policies, procedures, and internal controls. Should something be found amiss, it might mean having to restate previous operating results.
Mind you, these were simply the issues that news outlets homed in on late last week. Underlying these problems were a continued decline in margins, stagnant sales, and the sudden urge to pay down nearly $31 billion in debt.
Yet there was a precursor that Kraft Heinz could be in trouble long before its foundation turned to Jell-O this past week. Namely, the company's goodwill.
In its simplest form, goodwill represents the premium that one company pays when it's acquiring another, above and beyond accounting for tangible assets. Some goodwill is to be expected when making purchases. For instance, a premium is often needed to persuade the board of directors and/or management of a company to agree to a buyout. The goal, though, is that the purchasing company can create enough value from the combination that, either through cost synergies, intangibles such as tenured workers or management, or production/service expansion, this goodwill is eliminated over time.
Some goodwill is acceptable. However, Kraft Heinz had been lugging around $44.8 billion in goodwill at this time last year, representing more than 37% of its total assets. Between the expectation of recouping $44.8 billion in goodwill, as well as how much value Kraft Heinz places on its brands, the warning signs were there for investors.
Check out the latest Kraft Heinz earnings call transcript.
Caveat emptor, marijuana stock investors
But Kraft Heinz's pain could be some investors' gain, if they're paying close attention.
The rapid consolidation of stocks in the marijuana industry, and the monstrous premiums that've been paid for what transactions have been completed, have led to substantial goodwill accumulating on balance sheets in the early going. If a brand-name company like Kraft Heinz struggled to execute on its long-term strategy, the same problems could await pot stocks in an industry that's still trying to find its footing.
For example, Aurora Cannabis (NYSE:ACB) has made a habit of acquiring its way to the top production spot in Canada. Even though Aurora has mixed in a number of organic projects (Aurora Sky and Aurora Sun) and partnerships (Aurora Nordic), it's been a busy bee in the acquisition department. Last year, it acquired CanniMed Therapeutics for around $850 million, MedReleaf for about $2 billion, and ICC Labs for close to $200 million.
Unfortunately, about 80% of Aurora's deal to buy MedReleaf was labeled as goodwill, with essentially half or more of its other transactions labeled likewise. As of the end of its fiscal second quarter, 63% of the company's total assets ($3.06 billion Canadian out of CA$4.88 billion) were tied up in goodwill. There's little guarantee that Aurora Cannabis will be able to recapture this premium and may wind up taking large writedowns in the future.
Another prime offender is vertically integrated dispensary operator iAnthus Capital Holdings (NASDAQOTH:ITHUF). On the surface, it would look as if the U.S. dispensary model can do no wrong. But this is a model that's very cost-intensive, and it takes a lot of patience having to wait for cultivation licenses, dispensary licenses, and sales permits to come through. This is why acquisitions of established dispensaries, or at least those that are licensed, have been so popular within the industry, and for iAnthus.
But as of its latest quarter, iAnthus Capital was carrying $75.9 million in goodwill in relation to $137.3 million in total assets. Mind you, this data doesn't include the company's recently completed deal to buy MPX Bioceutical, the largest completed U.S. pot deal in history. I suspect this deal will substantially increase iAnthus Capital's goodwill and create a lot of future uncertainty for investors.
If marijuana stock investors don't want their foundation to turn to mush, they're going to need to be vigilant and keep a close eye on goodwill accumulating on pot stock balance sheets. Remember, some is OK and expected. But when it represents a significant chunk of total assets, you're just begging for trouble.