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Should You Buy Kraft Heinz Stock at Its All-Time Low?

By Leo Sun - Aug 12, 2019 at 7:08PM

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The packaged-foods giant’s headaches won’t end anytime soon.

Kraft Heinz's (KHC 1.31%) stock recently dropped to an all-time low after the packaged-foods giant simultaneously posted preliminary first- and second-quarter earnings results. For the first half of the year its revenue fell 5% to $12.4 billion, its organic sales fell 1.5%, and its adjusted earnings plunged 51% to $0.70 per share on higher impairment charges.

Those numbers didn't impress investors, who were still dazed by a $15 billion writedown, dividend cut, SEC probe, and delayed 10-K filing earlier this year. Unfortunately, Kraft Heinz's lackluster earnings report included another $1.2 billion in charges and writedowns, and it warned that it would delay its quarterly filing for the period ended June 29.

That barrage of bad news spooked the bulls and attracted the bears. But after an 8.6% sell-off the day earnings were reported, Kraft Heinz trades at about nine times forward earnings and pays a forward dividend yield of 5%. Will that low multiple and high yield set a floor under this stock?

A woman in business attire sits in a chair, her head in her hands. On the wall behind her are drawn question marks and a red arrow pointing down.

Image source: Getty Images.

The key problems

Like other packaged-foods giants, Kraft Heinz is struggling with competition from healthier, organic, and private label brands. Its management also focused too heavily on cutting costs instead of streamlining its portfolio, developing new products, and launching fresh marketing campaigns. Kraft Heinz also misstepped by using price cuts to boost shipments instead of using price hikes to offset lower shipments. That desperate strategy temporarily boosted its organic sales in the second half of 2018, but crushed the company's margins. Its organic sales turned negative again in the first half of 2019, although its adjusted EBITDA margin rebounded sequentially in the second quarter, according to the preliminary results it presented.

Metric

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Q2 2019

YOY change in organic sales

(0.4%)

2.6%

2.4%

(2.8%)

(0.3%)

Adjusted EBITDA margin

29.5%

25.3%

24.7%

24%

25%

YOY = year-over-year. Source: Kraft Heinz quarterly reports.

CEO Miguel Patricio, who took the top job in July, blamed the sales decline on "unfavorable promotional timing" in the U.S. and Canada, "difficult comparisons" to strong sales of U.K. soups a year ago, an unexpected "negative impact from lower inventory levels at retail in North America," and trade negotiations in Europe throttling its sales in certain regions.

In other words, Kraft's strategy of lowering prices, which reduced its pricing by 1.5 percentage points annually during the first half, didn't boost its sales. Major retailers are also reserving more shelf space for their own private label brands instead of Kraft's products.

Patricio attributed Kraft's margin declines to supply chain inflation, which increased its packaging, freight, overtime, and maintenance costs, as well as a "significant step-up in fixed costs" to support its sales growth.

A shopper puts a bottle of ketchup into a shopping basket.

Image source: Getty Images.

What's the turnaround plan?

Kraft Heinz is gradually raising prices across the U.S. to roll back the previous strategy of buoying sales with margin-crushing promotions. That shift boosted the company's adjusted EBITDA margin sequentially in the second quarter, but Patricio also warned that Kraft faces "further reductions in retailer inventory levels" and "accelerating key commodity costs" that were not anticipated at the beginning of the year.

Kraft divested two businesses, its nutritional beverages business in India and its natural cheese business in Canada, for over $1.5 billion during the first half of the year. Those divestments helped reduce its long-term debt from $30.8 billion at the beginning of the year to $29.8 billion, but no one else is lining up to buy its other withering brands, which include Breakstone's, Plasmon, Ore-Ida, and Maxwell House.

Patricio was previously the chief marketing officer of Anheuser-Busch InBev, where he revived the beverage giant's struggling Chinese business with fresh marketing campaigns, the expansion of local brands, and the premiumization of its Budweiser brand. Patricio believes that he can apply a similar premiumization strategy to Heinz ketchup and other evergreen brands.

But at Kraft, Patricio's marketing talents are hobbled by the company's massive debt and "zero-based budgeting" strategy -- a penny-pinching strategy that uses cuts in other areas to free up cash for new R&D and marketing strategies.

Sticking with zero-based budgeting is risky, since critics claim that Kraft Heinz's cost-cutting initiatives caused the accounting errors which triggered the SEC probe earlier this year. Kraft's delayed 10-Q filing indicates that those troubles aren't over yet.

Investors should avoid Kraft Heinz (for now)

Kraft Heinz's stock might look tempting at these levels, but the company isn't showing any signs of improvement and remains hampered by several issues. It also didn't offer guidance for the third quarter, leaving investors in the dark about its turnaround efforts. Investors should avoid this beaten-down stock until some flickers of life appear.

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