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Why You Should (Still) Avoid Kraft Heinz Stock

By Will Healy - Mar 22, 2020 at 11:37AM

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A run on grocery stores will not make the company's problems go away.

The recent phenomenon of quickly emptying store shelves has sparked renewed interest in consumer staples stocks such as Kraft Heinz (KHC 0.68%). Though Kraft Heinz itself has not rallied, many of its peers have held their value or increased in price during the recent market sell-off.

However, the unexpected surge in demand for consumer staples will not last. In time, demand for these products should return to normal levels as society overcomes the coronavirus.

Unfortunately for Kraft Heinz, this means the problems that have plagued the company for years will probably return to the forefront.

Empty shelves offer only limited upside

An unexpected surge in business has helped certain consumer stocks as other sectors swoon. At the time of this writing, the S&P 500 has fallen 29% year to date.

The front of a shopping cart viewed from the back in a grocery store aisle with shelves full of food products.

Image source: Getty Images.

Though Kraft Heinz is similarly down 31% in 2020, coronavirus fears did not hit the company quite as hard in the past few weeks. However, Kraft Heinz stock did not enjoy the short-lived surge that benefited rivals such as Kellogg's and General Mills.

Moreover, consumer stocks have largely suffered as major demographic cohorts such as millennials have turned away from packaged foods. This generation has greater demand for small, local producers and organic offerings. Kraft Heinz has failed to sufficiently adapt and cater to these consumer tastes.

Since many shelves remain empty, shoppers may buy what they can find for now. However, once the panic buying stops and consumers again have a wide array of choices, many shoppers will resume avoiding packaged foods.

The troubled union of Kraft and Heinz

Furthermore, the company faces its own set of financial troubles. In previous decades, both Kraft and Heinz existed as well-respected brands producing iconic foodstuffs. It made sense to many when Kraft and Heinz joined forces in 2015.

Among the investors this merger attracted was Berkshire Hathaway. The company led by Warren Buffett helped put the deal together with 3G Capital Partners. Berkshire owns 26.7% of the outstanding shares of Kraft Heinz.

Unfortunately, this union has become a rocky marriage as the company failed to adapt its product offerings as quickly as its peers. Many investors hoped that CEO Miguel Patricio, who took the job last year, would turn the tide for the company, but it remains to be seen whether his initiatives will bear fruit. 

Since reaching a high of nearly $100 per share in Feb. 2017, the stock has lost more than three-fourths of its value. Also, two major ratings agencies downgraded its debt to junk status on Feb. 14.

Berkshire's latest report showed that the conglomerate owned over 325 million shares of Kraft Heinz stock as of Dec. 31. Though the shareholder letter made little mention of the company, it acknowledged that the initial $13.8 billion investment has fallen in value. Considering that even Warren Buffett has struggled with his investment in this company, it becomes hard to imagine that the average investor will want to follow his lead.

Financial troubles endanger the dividend

Kraft Heinz also pays out an annual dividend of $1.60 per share, which yields 7.2% as of this writing. The company was hiking this payout every year after the merger until it cut the dividend in 2019.

This should come as no surprise as the payout ratio was over 100% in 2019. With the company dishing out every dollar of profit as dividends, the sustainability of the payout remains in question. Wall Street expects the company's revenue and earnings growth to remain sluggish over the next several years -- this bodes poorly for the future of the dividend.

Fearful families stocking up on food and supplies may help the company in the near term, and it may even boost Kraft Heinz stock for a time as investors looking for safe havens turn to defensive consumer names. Unfortunately, these trends will not last. Once the ongoing problems with Kraft Heinz's business return to the forefront, investors will probably resume their selling.

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Stocks Mentioned

Kraft Heinz Intermediate Corporation II Stock Quote
Kraft Heinz Intermediate Corporation II
$38.66 (0.68%) $0.26
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$417,700.00 (0.07%) $298.56
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$278.40 (0.04%) $0.12
Kellogg Company Stock Quote
Kellogg Company
$70.96 (0.34%) $0.24
General Mills, Inc. Stock Quote
General Mills, Inc.
$71.04 (0.58%) $0.41

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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