KHC - Kraft Heinz Co.

[LongHaul]

I'll throw my 2 cents in ( not sure how far I can throw pennies though).  There are a still a lot of really great brands at KHC.

The industry (obviously became much tougher to get growth from.

 

1.  If 3g is the only company cutting fat to the bone in a fat industry they have a nice relative advantage.

But if the industry competitors also cuts to the bone then their relative advantage is much less if any.

 

 

 

2.  I am going to lay out some data points and you can draw you own conclusions.

 

1.  Brazilian management team (mostly).

2.  29 year old CFO appointed in October 2017.

3.  2017 CFFO (adjusted for pension and A/R sold) was ~$1.5 billion below what I would have expected.  A lot of balance sheet items were way off from the +.4% organic sales in 4Q 17. 

4.  KHC 2017 10K filed 2/16/2018

5.  Buffett resigns from board on 2/23/18

6.  KHC missing earnings.

7  Sec investigation.

 

 

[Foreign Tuffett]

Again I disagree. You could get the ghost of Steve Jobs to run KHC and Oscar Meyer is STILL going to suck.

 

You'd have much more credibility if you spelled Oscar Mayer correctly, and attempted to back up your conclusion with some actual reasoning instead of just repeating it.

[petec]

Again I disagree. You could get the ghost of Steve Jobs to run KHC and Oscar Meyer is STILL going to suck.

 

You'd have much more credibility if you spelled Oscar Mayer correctly, and attempted to back up your conclusion with some actual reasoning instead of just repeating it.

 

...reasoning which is going to have to deal with the fact that volumes and sales are growing.

[petec]

 

3.  2017 CFFO (adjusted for pension and A/R sold) was ~$1.5 billion below what I would have expected.  A lot of balance sheet items were way off from the +.4% organic sales in 4Q 17. 

 

 

Would you mind elaborating on both your expectations for CFFO and the balance sheet?

[LongHaul]

I'll comment on the Balance sheet where there were red flags.  Cash flow was affected by balance sheet items.

 

Balance sheet vs ~0% sales growth in the 4Q of 2017

Real A/R +8.6%

Inventory +4.9%

Other Current Assets: +36.6%

Accrued marketing: -9.2%

Other Current Liab: -19% (taking out structured payables - pg 91 of 2017 10-K)

[LC]

Of Oscar Meyer? You’ll have to excuse the autocorrect :)

 

I don’t believe KHC breaks out sales and volumes by brand, if I am wrong I’d be happy to be corrected. Would love to invest here if I saw the tier 2 brands were doing well.

 

Again I disagree. You could get the ghost of Steve Jobs to run KHC and Oscar Meyer is STILL going to suck.

 

You'd have much more credibility if you spelled Oscar Mayer correctly, and attempted to back up your conclusion with some actual reasoning instead of just repeating it.

 

...reasoning which is going to have to deal with the fact that volumes and sales are growing.

[Spekulatius]

The question to me is if one likes the CPG sector, is KHC really the best bet? Something like SJM for example looks better to me in terms of valuation and the categories they operate in (coffee, pet foods). We will see more in a couple of days when they present their quarterly results.

 

Nestle seems to be the only sector stock that hasn’t been sent to the dog house, can it remain this way?

[wabuffo]

The question to me is if one likes the CPG sector, is KHC really the best bet?

 

POST is actually following the same acquisition/consolidation approach of KHC on a lesser scale (complete with the boatloads of debt - but without the nastiness/arrogance of 3G) and doing a better job of building shareholder value over the same time frame. 

 

I've owned it in the past but no longer do.  It has its fan-boys and its haters.  FWIW.

 

wabuffo

 

 

[Read the Footnotes]

I'll throw my 2 cents in ( not sure how far I can throw pennies though).  There are a still a lot of really great brands at KHC.

The industry (obviously became much tougher to get growth from.

 

1.  If 3g is the only company cutting fat to the bone in a fat industry they have a nice relative advantage.

But if the industry competitors also cuts to the bone then their relative advantage is much less if any.

 

Thanks for your well reasoned contributions, Longhaul.

 

The fact that Longhaul mentions relative advantage reveals part of the problem, which is that years ago a Kraft or Heinz investor might have felt they did not need to analyze relative advantage. In the past an investor might have been able to depend on a long history of consumer behavior and of stable market share to form an opinion of the future of the business.

 

I believe it likely that most consumer product brands are less valuable today than they were several years ago. There are multiple simultaneous trends driving that destruction of brand value, but the progress of technology is ultimately at the root of most or all of them. To me the question is more a matter of why should this be surprising and should we expect similar impairments at other companies even if accounting rules don't result in write downs?

 

Stable market share and slow changing market conditions could lead to lazy management and bloat. That in turn could provide 3G with an opportunity for cost cutting and rationalization.

 

The problem is that trying to execute 3G-style changes will be very challenging when at a the same time:

1. the value of KHC (and CPG) brands has likely diminished

2. Secular and cyclical trends appear to be working against the KHC portfolio of products, and

3. The product portfolio may have been neglected and in need of refreshing

4. There is a good bit of debt relative to the new diminished earning power

 

An additional issue is that this is a turnaround and turnarounds frequently take longer than expected. I am not sure why anyone would have expected  better progress to this point, but people do tend to be too optimistic regarding the speed of the timeline. Finally, these turnarounds are why we have a term like the PE "j curve". Even if the investment is ultimately successful, why shouldn't we expect the progress to look something like it has? This is part of why private equity usually doesn't leave the equity in the public, or why they would at least want to make sure they have 51% of the votes, as they do in this case.

 

A while back, I was helping a young person prepare to pitch a stock for a position at a large bank. They were successful in their job search, but their pitch was KHC. I believed that going long KHC at that time was a bad idea. I was surprised by how hard I felt I was having to work to be constructive regarding pitching KHC as a long at that time. The point being I was no fan of KHC. On the other hand, everything is a buy at some point, and there does seem to be some indication that there might be some of the following:

1. Overreaction to SEC involvement

2. Overreaction to non-cash impairment charges

3. Overreaction to a dividend cut

4. Potential for some of the cyclical trends to reverse in the future

5. Potential for some of the secular trends to prove to actually be cyclical

6. Kitchen sink/big bath management behavior

 

I am not saying that I would expect a home run for KHC, but on the other hand, I doubt I would feel I was working as hard to be constructive if a young person wanted help with a KHC pitch today. Also, as a BRK shareholder, I wouldn't object to BRK buying back shares of BRK, or buying more KHC after Friday's price action, or especially if the price of either continues to trend down. Ultimately what matters is will the businesses be worth more further down the line and not what the results are for the next couple of quarters.

 

[DTEJD1997]

Hey all:

 

Holy smokes!  KHC has a lot of debt!  I mean a LOT OF DEBT!

 

How much of their historical return has simply been from being insanely levered?

 

If they are having sales & profitability problems, they are going to have problems with their debt.  BIGLY PROBLEMS. 

 

The debt may be so large that once they have a PROBLEM with it and are trying to deal with it, it may be too late.

 

Even at $35, this thing may be "expensive" and VERY risky.

[scorpioncapital]

It's funny, I always thought KHC was higher up on the food chain and therefore should add more value compared to say a more 'basic material of foods' like Ingredion, which I also owned once. But that stock has not been such a disaster as KHC suprisingly. Maybe it's execution error or starting from a high base going in reverse to stabilize at a lower base. Or maybe they just haven't been fast enough to move on alternative products. I'm starting to think this is a little bit like Sears versus a retail REIT. Maybe in a commodity business where consumer preferences are constantly rearranging, the safest bet is to be the basic material - the landlord, the ingredient supplier, the data center and then you don't have to worry who is the winner or loser. More democratic and less risk.

[Ballinvarosig Investors]

Hey all:

 

Holy smokes!  KHC has a lot of debt!  I mean a LOT OF DEBT!

 

How much of their historical return has simply been from being insanely levered?

 

If they are having sales & profitability problems, they are going to have problems with their debt.  BIGLY PROBLEMS. 

 

The debt may be so large that once they have a PROBLEM with it and are trying to deal with it, it may be too late.

 

Even at $35, this thing may be "expensive" and VERY risky.

Agreed, especially in comparison to the cash flows. If this was a growth story, you could maybe overlook that a little. If this was even a company with a lot of fat that could be trimmed, maybe. As it stands, this things looks very vulnerable.

 

Looking at the company as a whole, when you look at some of the brands that this company sells, a few of them are not far off carrying a government health warning. The Lunchables for kids in particular strikes me as morally repugnant. Even for the supposedly quality brands like Heinz, I have to worry are they going to be as relevant going forward in the future. For example, I can buy an own brand tomato ketchup for 45p, the Heinz one in the same supermarket costs £2. You also have the headwind here were younger people are more price sensitive than brand conscious. I have to question whther management here really know what they are doing. They are a brands company, but yet they have been consistently cutting their advertising budget - https://www.statista.com/statistics/350602/us-ad-spending-of-kraft-foods/ I do not see how such short-term thinking can be good for the company in the long-term.

[Charlie]

Yesterday I read about a german retailer Edeka who used to sell Kraft Heinz products.

The article said that Kraft Heinz wanted price increases and Edeka wanted price decreases.

So there was no agreement and Edeka won´t sell Kraft Heinz products anymore....  :(

[Read the Footnotes]

 

Looking at the company as a whole, when you look at some of the brands that this company sells, a few of them are not far off carrying a government health warning. The Lunchables for kids in particular strikes me as morally repugnant. Even for the supposedly quality brands like Heinz, I have to worry are they going to be as relevant going forward in the future.

 

I looked at their product line to determine whether I had consumed any KHC products in the past ten years. I would guess that the only product my household bought might have been products in the Classico brand. Also, I recently had some Planters nuts, thanks to Packer16 (they were salty and delicious, thank you!). Other than that, I can't come up with anything I knowingly consumed in the last ten years.

 

While KHC products might not fit my personal tastes, it does seem to fit with Berkshire's taste for junk food as shown by the following list:

• Dairy Queen
  
• See's Candies
  
• Coca Cola--is water their only healthy offering?
  
• Mondelez International
  
• Restaurant Brands International
  
• Wal-Mart--Some locations have groceries, and those groceries have some high quality food, but still overwhelmingly junk offerings
  
• Costco--has a good bit of high quality raw ingredients, but also a lot of junk prepared foods, candy, etc.
  

Clearly Berkshire hasn't followed an ESG/whole foods thesis when seeking value in this space.

[DTEJD1997]

Hey all:

 

Holy smokes!  KHC has a lot of debt!  I mean a LOT OF DEBT!

 

How much of their historical return has simply been from being insanely levered?

 

If they are having sales & profitability problems, they are going to have problems with their debt.  BIGLY PROBLEMS. 

 

The debt may be so large that once they have a PROBLEM with it and are trying to deal with it, it may be too late.

 

Even at $35, this thing may be "expensive" and VERY risky.

Agreed, especially in comparison to the cash flows. If this was a growth story, you could maybe overlook that a little. If this was even a company with a lot of fat that could be trimmed, maybe. As it stands, this things looks very vulnerable.

 

Looking at the company as a whole, when you look at some of the brands that this company sells, a few of them are not far off carrying a government health warning. The Lunchables for kids in particular strikes me as morally repugnant. Even for the supposedly quality brands like Heinz, I have to worry are they going to be as relevant going forward in the future. For example, I can buy an own brand tomato ketchup for 45p, the Heinz one in the same supermarket costs £2. You also have the headwind here were younger people are more price sensitive than brand conscious. I have to question whther management here really know what they are doing. They are a brands company, but yet they have been consistently cutting their advertising budget - https://www.statista.com/statistics/350602/us-ad-spending-of-kraft-foods/ I do not see how such short-term thinking can be good for the company in the long-term.

 

You bring up a very important point.  Heinz ketchup is good, very good!  HOWEVER, when it cost MORE than 4x the house brand I've got to question it.  I can buy Kroger house brand for $1.  Is it as good as Heinz?  No, probably not, but it is 95% as good, and less than 1/2 the price.

 

All these brands and managers and investors who thought their product's price could rise a little bit faster than inflation (over decades) are in for a rude surprise.  You wind up with a "silly" situation where the house brand ketchup is 1/4 the cost of Heinz.

 

The times have also changed.  30 years ago, house brands and generic foodstuffs were frequently low quality.  That is no longer the case.  The quality of these foodstuffs has increased tremendously.  I have heard that Kraft is one of the largest producers of generic/house brands.

 

So 30+ years ago, branded items served a valuable function.  They let the consumer know that they would get a quality, CONSISTENT product at EVERY store, ACROSS the country.  Here in America, you've got WMT & Kroger & WFM that are essentially across the country.  Then you've got the super regionals. 

 

The utility of brands has declined tremendously and what we saw with KHC on Friday may just be the 1st step of a broader recognition of that.

[Spekulatius]

I checked our fridge and found Heinz ketchup and Heinz avocado mayonnaise there. I actually really like the Heinz avocado mayo. We do buy a lot of store brands. Generally for store brands, the discount to major branded items is more like 30%. My guess is that this may still be too high and entices customers to switching. KHC management  apparently fights this problem by lowering the price gap and reducing their margins of course to defend and grow market share. My guess is that consumers will accept some premium for branded items, but less than it is currently.

 

One of the somewhat scary part of this whole issue that it is occurring when the economy is strong and there is full employment. Throw in a weaker economy when more folks are watching their expenses and the trend towards commoditization in CPG could grow to another level.

[DooDiligence]

For years now I've been buying whatever condiment is the cheapest.

 

Currently long Blue Plate mayo & Great Value mustard.

 

A few months ago I bought a jar of GV peanut butter.

 

Tastes just as good as Jif / PP / Skippy at less than half the price.

(the ONLY jelly I EVER buy is Bonne Maman Wild Blueberry bc it's berry good)

 

https://www.bonnemaman.us

 

If Great Value improved the labels & gave the product better shelf locations, what would happen to the zombie brands?

[Read the Footnotes]

Hey all:

 

Holy smokes!  KHC has a lot of debt!  I mean a LOT OF DEBT!

 

How much of their historical return has simply been from being insanely levered?

 

If they are having sales & profitability problems, they are going to have problems with their debt.  BIGLY PROBLEMS. 

 

The debt may be so large that once they have a PROBLEM with it and are trying to deal with it, it may be too late.

 

Even at $35, this thing may be "expensive" and VERY risky.

 

I agree with your point that "this thing may be . . . VERY risky" if you define risk as a volatile equity price due in part to operating leverage and financial leverage. Plus there will be uncertainty and likely volatile results as 3G continues to make changes.

 

I also agree that there is a lot of debt, but the scary ratios like debt/equity really don't contribute much to the story here. I agree that continued serious degradation of the business would eventually become a serious issue for the company, but to really assess the risk, you really need to look at maturities, coverage ratios, etc.

 

The credit ratings (which I put little confidence it) don't seem to indicate imminent demise, yet:

 

• Moody's® Rating Baa3 (05/21/2018)
  
• Standard & Poor's Rating BBB (03/23/2018)
  

 

The bond market itself also seems far more positive than the ratings agencies. Here are a couple of bond examples:

 

KHC 3.95% of 7/15/2025 went from 4.01% to 4.09% on 2/22/19

KHC 5.00% of 6/4/2042 went from 5.58% to 5.72% on 2/22/19

 

Not only are these current yields not indicative a company in distress, the moves of a few bps indicate that the bond market responded with a yawn on Friday, when at the same time the equity market sold off the stock by 27.5%. Does that seem to be an illogical disconnect between the two markets in this case?

 

I haven't looked deeply in to the company, and I'm just using data service outputs, but the debt service multiples I saw didn't look that concerning. If I were to make a big bet on this, I would prefer to do my own work on that matter, if I had concerns.

 

At the current EV/EBITDA with expectations of a melting ice cube, it would be hard to think of it as cheap. On the other hand, there are also positive results to be found in the financials over the past couple of years. If KHC management can achieve their stated goals including a bit of de-levering, KHC could be found to be very cheap.

 

It would be far easier for someone who was an expert on the company, the management, and current qualitative factors to make the argument that KHC has gotten cheaper. That is why I previously wrote that as a shareholder of BRK, I would be very happy if I woke up one day to discover BRK had bought more. I believe Buffett, Munger, Abel, Combs, Weschler and others might find it easy to make a quick determination about future prospects and the opportunity at hand.

[Spekulatius]

The bond market itself also seems far more positive than the ratings agencies. Here are a couple of bond examples:

 

KHC 3.95% of 7/15/2025 went from 4.01% to 4.09% on 2/22/19

KHC 5.00% of 6/4/2042 went from 5.58% to 5.72% on 2/22/19

 

I believe the dividend cut (allowing for more FCF after dividend payments) soothed the bond market. I also think that this dividend cut was a good decision. If credit becomes and issue, I am sure that BRK would help out, albeit at a price.

[DTEJD1997]

Hey all:

 

Holy smokes!  KHC has a lot of debt!  I mean a LOT OF DEBT!

 

How much of their historical return has simply been from being insanely levered?

 

If they are having sales & profitability problems, they are going to have problems with their debt.  BIGLY PROBLEMS. 

 

The debt may be so large that once they have a PROBLEM with it and are trying to deal with it, it may be too late.

 

Even at $35, this thing may be "expensive" and VERY risky.

 

I agree with your point that "this thing may be . . . VERY risky" if you define risk as a volatile equity price due in part to operating leverage and financial leverage. Plus there will be uncertainty and likely volatile results as 3G continues to make changes.

 

I also agree that there is a lot of debt, but the scary ratios like debt/equity really don't contribute much to the story here. I agree that continued serious degradation of the business would eventually become a serious issue for the company, but to really assess the risk, you really need to look at maturities, coverage ratios, etc.

 

The credit ratings (which I put little confidence it) don't seem to indicate imminent demise, yet:

 

• Moody's® Rating Baa3 (05/21/2018)
  
• Standard & Poor's Rating BBB (03/23/2018)
  

 

The bond market itself also seems far more positive than the ratings agencies. Here are a couple of bond examples:

 

KHC 3.95% of 7/15/2025 went from 4.01% to 4.09% on 2/22/19

KHC 5.00% of 6/4/2042 went from 5.58% to 5.72% on 2/22/19

 

Not only are these current yields not indicative a company in distress, the moves of a few bps indicate that the bond market responded with a yawn on Friday, when at the same time the equity market sold off the stock by 27.5%. Does that seem to be an illogical disconnect between the two markets in this case?

 

I haven't looked deeply in to the company, and I'm just using data service outputs, but the debt service multiples I saw didn't look that concerning. If I were to make a big bet on this, I would prefer to do my own work on that matter, if I had concerns.

 

At the current EV/EBITDA with expectations of a melting ice cube, it would be hard to think of it as cheap. On the other hand, there are also positive results to be found in the financials over the past couple of years. If KHC management can achieve their stated goals including a bit of de-levering, KHC could be found to be very cheap.

 

It would be far easier for someone who was an expert on the company, the management, and current qualitative factors to make the argument that KHC has gotten cheaper. That is why I previously wrote that as a shareholder of BRK, I would be very happy if I woke up one day to discover BRK had bought more. I believe Buffett, Munger, Abel, Combs, Weschler and others might find it easy to make a quick determination about future prospects and the opportunity at hand.

 

The bonds may have moved very little the other day...BUT did they make a big down move previously?

 

Also, as has been astutely pointed out by Spekulatius, the dividend is being cut and presumably a LOT of that FCF will be going to service debt instead of a dividend...so get a LOT more safety there from the bondholder's perspective.

 

Then you've STILL got TENS of billions in book value/equity ahead of the bonds.

 

Finally, I don't think KHC is a house of cards, ready to collapse overnight...Their brands are STILL going to sell, and they are STILL going to make money.  The question is just how much money that is going to be. 

 

If management can execute on their plans, lower prices, lower costs, take some market share, reduce debt, make operational improvements...then the hit to the value of the EQUITY might be small to medium.

 

If management makes a mistake OR simply can't pare expenses faster than they lose market share...that debt is going to be VERY DIFFICULT to get ahead of.  Not now, not next year, but after 4-5 years of decline, it could be a serious, serious problem.

 

I think it will probably be somewhere in the middle.  Management will do some things right...but lack on a couple others...the dividend is cut, they gradually lose market share, and earnings contract a bit.  Maybe in 5 years the stock is in the high 20's?  Not a catastrophe, but not a good situation either.

 

We will see. One thing I am sure of though is that I would NOT want to be a shareholder, not now, not at $35/share.

[SharperDingaan]

Just to add some backround here, as I have partners with deep CPG experience.

 

CPG branding used to substitute for quality, and experience (physical product); today it's more experience, and story (mostly show).

I buy Heinz because it tastes great, its nostalgic, and to show that I can afford it; if I just wanted ketchup, there are many other better value choices. Grandpa and dads choice, not the younger sets. 

 

Once in a chain restaurants value chain, it's hard to fall out of it.

At high volumes Heinz can be offered at marginally above cost, and still sell at well below the price of a value brands. But if the restaurant offered you a value brand ketchup to go with your sit-down fries, versus Heinz .... would you still go there as much? If they're even trying to save money on ketchup, they must REALLY be in trouble? Sticky business.

 

Heinz isn't going away, but it doesn't have the runway that it used to have.

Everything has a product life cycle, and CPG (Heinz products) are a lot further along it than they were in the 50's - 90's. Many are arguing that CPG is actually in the mature/decline stage. Does your family still eat as many cornflakes every morning as it did even 3 years ago? who's still eating it? and why? Were it not for habit .....

 

SD

 

[aws]

We certainly have to hope 2019 will be the bottom as this trend is certainly not encouraging: 2017 Adj EBITDA 7.8b, 2018 7.1b, 2019 projected 6.4b.  Even at 35/sh it's still at almost 12x forward EV/Adj. EBITDA which can hardly be considered cheap.

[Read the Footnotes]

 

Heinz isn't going away, but it doesn't have the runway that it used to have.

Everything has a product life cycle, and CPG (Heinz products) are a lot further along it than they were in the 50's - 90's. Many are arguing that CPG is actually in the mature/decline stage. Does your family still eat as many cornflakes every morning as it did even 3 years ago? who's still eating it? and why? Were it not for habit .....

 

SD

 

Good points. I thought the following article is a nice complement your comments and posts from others. It's also reassuring to see management confronting these issues publicly.

 

https://www.forbes.com/sites/antoinegara/2018/04/30/jorge-paulo-lemann-says-era-of-disruption-in-consumer-brands-caught-3g-capital-by-surprise/#438c309e1f9b

 

“I’ve been living in this cozy world of old brands and big volumes," said Lemann. “We bought brands that we thought could last forever,” and borrowed cheap money to do so, he added: “You could just focus on being very efficient... All of a sudden we are being disrupted.”

 

[aws]

https://www.cnbc.com/2019/02/24/kraft-heinz-reviews-options-for-maxwell-house-coffee-including-sale.html

 

$400mm EBITDA and talk of a price in the $3B range.  Obviously those numbers may be way off, but doesn't make things sound great if you were to divest something at 7.5x EBITDA when you're trading at 12x overall.  Another share price plunge tomorrow?

[rb]

https://www.cnbc.com/2019/02/24/kraft-heinz-reviews-options-for-maxwell-house-coffee-including-sale.html

 

$400mm EBITDA and talk of a price in the $3B range.  Obviously those numbers may be way off, but doesn't make things sound great if you were to divest something at 7.5x EBITDA when you're trading at 12x overall.  Another share price plunge tomorrow?

In most likelyhood they're probably not divesting their best/leading/high performing brands. They're divesting laggards so you should expect lower multiples.