The merger between Kraft Foods and H.J. Heinz was announced months ago, and the first earnings announcement for the combined Kraft Heinz Company (NASDAQ:KHC) was released this week, though the two entities' results were still reportedly separately. With an expected slump in the top line numbers and synergies being the main focus, its aspirations are to reach $1.5 billion in cost savings between the two companies in the next two years. Investors have little insight into progress on that front, however, as the company deemed it unnecessary to hold an earnings conference call.
A full transcript follows the video.
Dylan Lewis: We've got Lewis-Shen talking about Kraft Heinz on this CG episode of Industry Focus.
Greetings, Fools! I am Dylan Lewis coming to you from sunny Alexandria, Virginia. To my left is half-man, half-amazing Vincent Shen. Vincent, how are you doing today?
Vincent Shen: I'm doing really well. How are you doing?
Lewis: It's interesting to be in the host seat. Now, I'm subbing in for Sean. It's unfamiliar territory.
Shen: Yeah, I will be doing similar for the tech show for you this Friday.
Lewis: Yeah. Listeners be ready. What are we talking about today, Vince?
Shen: We have two parts. The first one being the big earnings release last night. We touched on this back in March when the deal was first announced to create the mega food and beverage company Kraft Heinz. The $50-billion deal approved and officially started trading as KHC in early July.
This is their first earnings release as the combined entity. Obviously, for the second quarter, they're reporting them as separate entities. Overall, I can't say I'm really surprised.
Lewis: How did earnings look?
Shen: At Kraft, net revenues were down about 4.9% year over year, with a small foreign-exchange impact. Kraft has much less of an international business compared to Heinz. Five out of the six segments reported down sales. With 3G Capital being infamous for its cost-cutting measures, the operating income was actually up 5.6% year over year for the quarter.
Diluted earnings per share were up 15% to $0.92 per share. Overall, they're attributing growth to their bottom line to favorable commodity costs, lower SG&A -- a lot of that being advertising spending -- and lower manufacturing costs driven by some of their cost-cutting measures.
Lewis: That's all stuff you'd expect to see drop off if someone's focused on efficiency and dropping costs.
Shen: Exactly. Over at Heinz, the net revenue was down about 4.1% year over year to $2.16 billion. Heinz business having a much larger international segment actually saw a really big 9.4% foreign-exchange negative impact.
Lewis: That's a big hit.
Shen: Yeah. Very significant. Their adjusted EBITDA was up 6.7% year over year despite that foreign-exchange impact. We're seeing how some of the cost-cutting measures are helping them in that regard. Ultimately, they reported a loss off about $0.91 per share. They were able to get higher pricing, and they saw better sales performance in North America and Latin America. That was pretty much offset by declines in all the other international segments.
Lewis: I think that's something we see with all the large multinationals this reporting period. The strong dollar is going to impact anyone with large international segments.
Shen: Yeah. That's been a trend for some time now, for the past few strings of releases for these companies.
Lewis: It's something to be mindful of, but not overly concerned with. It's just a reflection of the fact that they're a huge company with international scale. All in all, are these results good? Are they bad? Are they what we expected?
Shen: When 3G Capital came in, there was a lot of talk about by 2017, they're expecting at least $1.5 billion in cost synergies and reductions. Those would be workforce reductions, increases in productivity, and 3G does something called zero based budgeting, where it's every year, instead of trying to work off last year's budget and updating it for this upcoming year, they start everything from scratch.
What that allows them to do is really tighten the belt. They will push any reductions like nothing is too small. Be it printing on both sides of the paper, they're talking about how a lot of Kraft products are offered to employees for free, so there have been reductions in that.
Lewis: I'm sure they're not happy about that.
Shen: Exactly. Even executives who are traveling for business now are bunking up together in hotel rooms. Whereas before they might have had their own nice presidential suite or something. Well, now you've got a roommate. Those things are what 3G Capital has been doing . . . a Brazilian P/E Fund. I think that definitely has some concerns for me long term, but we can get to that in a little bit.
Otherwise, Heinz is the more international business, and saw much more of a negative impact from foreign exchange. Another thing I thought was worrisome for me is the company didn't see the need to hold an earnings call with analysts. Nearly every other company that's publicly traded does -- big or small
Lewis: That's a huge source of insight for investors in terms of what's been going on, some added commentary to some of the numbers that we look at on an earnings report. It also gives you a sense of what's coming down the pipeline.
Shen: Of course. Think about it: This company is in a huge stage of transition. To have no guidance about what they're expecting with the rest of the year with the integration efforts, how successful things are looking; it definitely leaves the entire market shrugging their shoulders like, "What is going on here?"
Lewis: I know a lot of times with the quarterly calls we get a little more depth to the numbers, and we hear a bit more of the story. Sometimes, you'll see stocks that look like they had good top line and bottom line numbers that wind up dropping after hours because the quarterly calls have something that is not so glamorous.
It's kind of tough to not have those indicators in there. Do you think it's something that we might see an issue within a month or so where we start to get more details that could shock the stock one way or the other?
Shen: I think you bring up a really good point. Like you said, after the earnings call, the stock might have action. The headline numbers might not look great, but there's actually some really great long-term developments with some projects at a company, and that pushes the stock higher. Over the next few months, I think the KHC shares might be more susceptible to some volatility because, as news does come out, investors are hearing it for the first time since they didn't get any guidance from an earnings call.
Lewis: Right. Is there anything in particular that you're going to be looking at moving forward with the company?
Shen: Sure. 3G is going to remain very focused with reducing spending via advertising, and some of the other little things that I mentioned earlier, and to hit that $1.5 billion goal. They're going to really want to maximize the bang for its buck, and at the same time, by pushing a lot of their spending toward the better-performing brands like Heinz ketchup, and moving away from underperforming ones like gravy sauces and things like that.
The question looking long term is, how much of that reduced spending for these underperforming brands is going to hurt them permanently? I think what a lot of people are concerned with as they follow this company is that 3G might be focused a bit shortsighted. As a result of that, it could have a very negative long term impact on a significant portion of their portfolio, when they only focus on the top performers. I'm not saying that's a bad strategy, but it's something that should be kept in mind.
Overall, the problem is that the entire company faces some industry headwinds with the fact that they serve packaged, processed foods, and there's been a big shift for consumers toward natural, organic offerings. That's going to be something that hits them doubly.
Lewis: Great. Thank you for your insight. Before we get into the second half of the show, I want to make everybody aware of a very special offer for all of Industry Focus listeners. If you like what you hear on the show, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner.
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Now, looking at some other CG stuff going on in the marketplace, I couldn't help but talk about Verizon today after some big news dropped earlier this week.
Shen: Last Friday, Verizon followed in T-Mobile's footsteps. T-Mobile did this two years ago. Verizon became the second major wireless carrier to end subsidies for their new customers. The system that I was used to for a long time was, I'm going to pay $100, or $200 for the newest iPhone, or the newest Galaxy -- whatever high-end flagship device. As a result of that, my monthly bill is a little higher because I'm paying off the subsidy for the device.
They're going to stop offering that to new customers. Starting August 13th, they're focusing on what they're calling their "Small, Medium, Large, and Extra Large" plans. There are four options tiered based on the amount of data that's offered in the plan. In terms of the cost of the device, you either pay the retail price upfront, or you join the Verizon Edge program and you pay it off in monthly installments. They're no longer offering those subsidies.
Lewis: That could be a big upfront spend for a subscriber.
Shen: One concern going forward is, if people have always been on these subsidy-based, two-year contracts, they don't realize how much these devices cost. A lot of them are upwards of $600 to $700. Trying to pay that up front might be a pretty tough pill to swallow. Then paying it off in the installments is not exactly like the two-year contract because of the early termination fees.
But just because you're no longer set in a two-year contract, if you're paying off that phone in installments, your freedom to switch does still require you to pay off that device.
Lewis: That's true. All in all, is this better or worse for subscribers?
Shen: Going through the plan itself, there's a 1GB where you're paying $30, then 3GB you're paying $45, 6GB is $60, 12GB is $80. That's their small, medium, large, and extra large. In addition to that, into the base bill you're also paying $20 for the access fee per line. Maybe $10 for a tablet or hot spot, $5 for another connected device like a smartwatch. Ultimately, I think there's a 10-device limit per plan.
Looking at it, are most subscribers going to see lower or higher bills? I think this really depends because Verizon did have a bit of a complicated system in the past with their different offerings. They say they're offering this new system to simplify things for everybody. That's definitely a plus, but whether or not your bill is going to be going up overall -- I think it really depends on your situation.
Tom's Guide had a really interesting chart. For the four different levels of data, if you have 1GB and it's by yourself, you can expect to pay about $50. Then, if you want the extra large, you're a power user, you need 12GB; you're going to pay $100. Keep in mind, that does not include any installment payment if you're doing Verizon Edge.
Lewis: Right. The phone would be on top of that, then.
Shen: Exactly. He also had a comparative. For a family of four, based on what it will be going forward with the new plans, and what it was previously; some of the small and medium plans -- 1GB and 3GB -- you're maybe saving $20 to $25 a month. On the large and extra-large ends you might be paying $10 or $20 more.
I think that has to do with the different access fees that Verizon used to charge. They ranged from $15 to $25. It will really depend on your situation. You should take a look at what you're paying, what you're considering, and you also have to consider things -- as you mentioned before the show and we were hoping to answer this question -- it also depends on where you might be in your upgrade cycle and things along those lines.
Lewis: When I saw this news, something that immediately came to mind with me was that I have a Verizon upgrade. My two year contract ended in late June. I was hoping to hold off, wait for the new iPhone to drop and then get a nice subsidized iPhone and lock up another two year contract with them.
I think something a lot of people are wondering is: are those existing upgrades going to be honored, or are they going to be grandfathered into this new system? Any insight from any tech outlets on what's going on with that?
Shen: To be clear, the customers who are currently on the subsidized two year contract model are allowed to stay on that. They're not going to be required to change right this moment when things kick off later this week.
That said, it will depend on where you are in you upgrade cycle. You mentioned that your upgrade came up in June. For people who are eligible for that upgrade and they want to stay in the old system, general indications from the company -- and I don't know if they're officially confirmed -- but a lot of the tech outlets have pointed in the direction of Verizon allowing that to continue.
It looks like you'll be able to upgrade to the new iPhone when it drops later this year. I'm crossing my fingers for you, I'm hoping that works. If you're on the current contract model and it comes up in your situation, they're going to push very hard for you to move to this new model.
Lewis: Yeah. That's something they did with all the unlimited data plans. They tried desperately to get people off the plans that they saw weren't being as profitable for them.
Shen: Exactly. In the end, I'm sure this company went through every level of the plan, and made sure that their bottom line was working for them. For switchers who have paid off their entire phone and are eligible for an upgrade, and they want to make the change, they get to move to the new system. We talked about what the base rates are, and the standard access fee is still $20, like what's advertised.
There's going to be some people who aren't eligible for an upgrade yet who want to switch over. In that case, they're going to have to pay double. They'll have to pay a $40 access fee, then once they hit their upgrade date they'll come back to $20. That's because the company says that initially you got that subsidized phone at a really nice price. This is to offset that.
Lewis: So you have a steep price to pay there in the beginning.
Lewis: I have to say, I think they're pretty smart in how they do their bucketing for this. I'm currently on a 2GB plan. I'm looking at this, and I feel like I'm trapped between the 1GB and the 3GB. Realistically, I'm probably going to go toward the 3GB, just because I don't want to get slapped with overages.
Shen: Exactly. They're not going to be cheap. For any of these plans, I think I saw that, for every GB you go over, is going to be an extra $15. Just like that, if you're on the 1GB plan and you go over to 2GB, you're paying $65 anyway. You might as well do the 3GB. It basically pushes you up into the second bucket.
Lewis: Can you really put a price on peace of mind? Knowing that you won't be going over your data? Awesome. Any other thoughts for us, Vince?
Shen: Yeah. For the people who really crush data every month and are watching 1080p HDTV on their phones, or mobile devices, the 12GB is called the extra large, but it's not their biggest. They have options from 20GB for $120 up to 100GB at $750. That's probably more of a corporate, or very large family, or some type of business account.
Lewis: That's a month's rent.
Shen: There are options. It doesn't max out at the 12GB. Also, another thing I wanted to mention is, for people who are in the nice situation where their employers or companies help to cover some of the cost of their monthly bill, sometimes the company might cover your bill, but not the device. You are in a better situation where you're paying that subsidized price of $100 or $200, and then letting your monthly bill be higher because your employer's got the check.
In this case, due to the new option for paying upfront might not be your best option. That's really just going to lower the bill for whoever's paying it. That's just something to keep in mind for those of us who have that nice perk.
Lewis: Interesting. Great talking to you, Vince. I appreciate all your thoughts.
Shen: Yeah, no problem.
Lewis: As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. Thanks for listening, and Fool on!