Kraft-Heinz: Potentially Undervalued Food Stock

Kraft-Heinz (KHC) is among the largest publicly traded packaged food stocks in the world. Recently the company received a lot of attention due to reporting a huge asset impairment for the fourth quarter and cutting its dividend by more than 30% on the same day.

The market’s negative reaction to these news items has made Kraft-Heinz’ share price drop to a very low level. While the company’s dividend cut no longer makes it a trustworthy long-term holding for dividend growth investors, it does have appeal for value investors. The stock could be undervalued, and even with the dividend cut, it has an attractive 5% dividend yield. After the recent dividend cut, the dividend also looks relatively safe, and the yield is still relatively high at 5.0%, making Kraft-Heinz a high-yield dividend stock.

Company Overview           

Kraft-Heinz is a major player in the packaged foods/beverages industry. The company sells condiments, sauces, cheese & dairy products, as well as frozen & chilled meals and infant diet products to consumers all around the globe. Kraft-Heinz was created in 2015 through a merger that was orchestrated by Warren Buffett (Berkshire Hathaway) and 3G Capital. Kraft-Heinz, which is headquartered in Pittsburgh, Pennsylvania, is currently trading with a market capitalization of $39 billion.

Kraft-Heinz reported its fourth-quarter earnings results on February 21^st. The company reported a massive net loss of $12.6 billion for the fourth quarter, which was not due to operating losses, but rather due to a huge asset impairment charge. Kraft-Heinz wrote down the asset value of the Kraft as well as of the Oscar Mayer brand, as the outlook for these business units is not as good as management had previously estimated.

Adjusted for this one-time expense, Kraft-Heinz would have generated EBITDA of $1.7 billion on revenues of $6.9 billion. Revenues were up slightly during the fourth quarter, adjusted for currency rate changes revenues would have risen by 2.4% year over year.

Growth Prospects and Outlook

After having battled with weak to now top line growth for a while, Q4 of 2018 has been a better quarter for Kraft-Heinz when it comes to revenue generation. The company’s 2.4% organic sales growth rate was not overly strong on an absolute basis, but for a company that is active in a low-growth industry such as packaged foods, that is not an especially weak growth rate, either.

Kraft-Heinz plans to grow its revenues during 2019 and beyond as well, together with improved portfolio management and balance sheet deleveraging. The company should be able to grow its revenues in international markets going forward, as rising disposable incomes in countries such as China and India allow consumers to purchase higher-priced branded goods from US-based companies. That said, overall sales growth is likely to be modest, given the slowdown in the core U.S. market.

Still, future EPS growth is possible. If Kraft-Heinz can manage to get its costs under control, profits should rise in line with revenues. Kraft-Heinz’ deleveraging efforts should positively impact the company’s profitability, as interest expenses should decline going forward. Therefore, future EPS growth of 3%-4% annually is achievable for Kraft-Heinz in the long run.

Dividends And Expected Returns

Kraft-Heinz is expected to produce EPS of roughly $3.70 this year, which means that shares trade at roughly 9 times this year’s earnings. This represents a substantial discount relative to how the company’s shares were valued in the past. Even when we assume that the valuations Kraft-Heinz traded at during 2015-2017 will never be achieved again, the company could still easily see multiple expansion towards a 10-12 times earnings multiple. Therefore, multiple expansion could provide an annual tailwind of ~4% to Kraft-Heinz stock returns.

Factoring in the 5% dividend yield, total returns could reach 12%-13% annually going forward, which seems attractive for value and income investors. The dividend is well-covered at the newly reduced level, as Kraft-Heinz will pay out just ~43% of its net profits as income this year.

Final Thoughts

Kraft-Heinz has not been a good investment over the last couple of quarters, but going forward shareholders could see strong returns, based on a high current dividend yield and its very low valuation. However, the company’s large dividend cut means it is no longer a good pick for long-term dividend growth. Instead, value investors interested in the stock could consider buying shares at their presently undervalued levels and selling near a fair value estimate of $39.