KHC - Kraft Heinz Co.

[DooDiligence]

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?

 

Good to the last drop?

[Spekulatius]

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.

 

Of course they divest underperforming brands, but if the company trades at 12x EBITDA and some brands are worth only at 7.5x, the implied valuation for the rest (which isn’t doing that great ithetn) seems pretty rich. Disposing of a business for 7.5x EBITDA doesn’t look great for the credit metrics either.

[Read the Footnotes]

https://www.cnbc.com/2019/02/25/buffett-says-berkshire-hathaway-overpaid-for-kraft-following-last-weeks-stock-plunge.html

 

If Buffett says he overpaid at ~$30/sh cost basis years ago, think about how far off $70/sh a couple of years ago was.

 

I never understood the valuation at that point. I assume a Buffett/Berkshire halo effect contributed to the overvaluation.

[aws]

It's interesting that Buffett said this morning that he thinks he overpaid for Kraft, but not for Heinz.  Since the Kraft deal was largely equity, I wonder if he is implying that Berkshire would be much better off today if the deal never happened, or if just that the price of Kraft as implied by the equity values at the time was excessive.

 

I didn't follow the deal that closely at the time so I'm trying to rework the numbers now and hope I have it roughly correct.  Berkshire paid 4.25b for 51% of Heinz implying an 8.33b equity value in 2013.  Immediately before the merger announcement Kraft was $62/sh or about 38b total equity value.  Heinz offered 51% of their equity for 49% of Kraft's equity, and would add $10b as a special dividend to Kraft shareholders.  Heinz would be getting 49% of $38b, or just under 19b, in exchange for $10b + 51% of their equity, which implied that their equity was worth about 16.5b (2 times what they had paid for it 2 years earlier).  Then after the announcement as the price of Kraft ran up the implied value of the Heinz equity got sillier.  At the date of the closing Kraft was $88/sh, and since no additional cash was being paid then the runup implied a much higher value of the Heinz consideration as well.  At $88/sh for Kraft, Heinz had an implied value of $32b which is almost 4 times what they paid for it.

 

I think the way all of the accounting was done it used that hugely inflated number.  It was booked as though Heinz paid $42b for 49% of Kraft, which was their $10b cash plus $32b for their equity.  Now I don't think anyone would argue at this point that the price was excessive, but it was also a fiction.  If Kraft ran up to $100 or $150 before the merger, the implied value gets sillier and sillier, but Heinz real cost remains the same.  The write down last week removes some of that fiction from the price, but still implies that Heinz got an ok deal. 

 

How much do you think Heinz would have been worth today if they never made the deal?  If Buffett could undo the deal today and have Berkshire and 3G get their 10b and 100% stake in Heinz back, would they do it?

[rkbabang]

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.

 

Of course they divest underperforming brands, but if the company trades at 12x EBITDA and some brands are worth only at 7.5x, the implied valuation for the rest (which isn’t doing that great ithetn) seems pretty rich. Disposing of a business for 7.5x EBITDA doesn’t look great for the credit metrics either.

 

Also, I think consumer brands for commodity goods are less important in the age of the internet where information is cheap, quick, and abundant.  In the old days you bought the brand you were familiar with, because it was the safest thing to do.  The brand itself carried the information you needed to make your decision.  Now if I see a product I never heard of that has a close to 5-star rating on Amazon with thousands of reviews I feel comfortable buying it.  Also much of the brand power has switched from the individual products to the retailer.  If Whole Foods carries something, people feel safe trying it, if Amazon brands something with it's Amazon brand, rather than thinking of it as "generic" people feel safe giving it a try.  Even in a more traditional grocery store if you see something you've never tried, you can google it right there in the isle to help you make the decision.  Gone are the days where a well known brand can survive with mediocre products or overpriced products.  The brand itself just isn't as important as it used to be, and will get less and less important as time goes on.

 

[tooskinneejs]

Old article from 2015 talking about the deal valuation and wondering whether Buffett and Heinz overpaid for Kraft (turns out they did)...

 

http://fortune.com/2015/03/26/buffett-heinz-paying-for-kraft/

 

 

[rolling]

It's interesting that Buffett said this morning that he thinks he overpaid for Kraft, but not for Heinz.  Since the Kraft deal was largely equity, I wonder if he is implying that Berkshire would be much better off today if the deal never happened, or if just that the price of Kraft as implied by the equity values at the time was excessive.

 

I didn't follow the deal that closely at the time so I'm trying to rework the numbers now and hope I have it roughly correct.  Berkshire paid 4.25b for 51% of Heinz implying an 8.33b equity value in 2013.  Immediately before the merger announcement Kraft was $62/sh or about 38b total equity value.  Heinz offered 51% of their equity for 49% of Kraft's equity, and would add $10b as a special dividend to Kraft shareholders.  Heinz would be getting 49% of $38b, or just under 19b, in exchange for $10b + 51% of their equity, which implied that their equity was worth about 16.5b (2 times what they had paid for it 2 years earlier).  Then after the announcement as the price of Kraft ran up the implied value of the Heinz equity got sillier.  At the date of the closing Kraft was $88/sh, and since no additional cash was being paid then the runup implied a much higher value of the Heinz consideration as well.  At $88/sh for Kraft, Heinz had an implied value of $32b which is almost 4 times what they paid for it.

 

I think the way all of the accounting was done it used that hugely inflated number.  It was booked as though Heinz paid $42b for 49% of Kraft, which was their $10b cash plus $32b for their equity.  Now I don't think anyone would argue at this point that the price was excessive, but it was also a fiction.  If Kraft ran up to $100 or $150 before the merger, the implied value gets sillier and sillier, but Heinz real cost remains the same.  The write down last week removes some of that fiction from the price, but still implies that Heinz got an ok deal. 

 

How much do you think Heinz would have been worth today if they never made the deal?  If Buffett could undo the deal today and have Berkshire and 3G get their 10b and 100% stake in Heinz back, would they do it?

Thank you. Now it makes much more sense. Just a further question: heinz goodwill also had to be written up right? Because at book heinz would be worth about 8B and they were paying 14B for 49% of Kraft. However at the closing they ended up "paying" 42 B and Heinz was worth 32B. This would mean an extra  24B goodwill on the balance sheet just for the heinz part, plus the extra goodwill and intangibles needed for the run up in Kraft share price. In a limit situation, this could mean that goodwill and intangible assumptions were unreasonably high and that a write off might be of little meaning.

 

Am I wrong?

 

 

 

[aws]

I think Heinz got a write-up as well as part of the merger.  I haven't dug into the accounting there too deeply, but all the adjustments should be spelled out in the S-4 here if you're interested.  https://www.sec.gov/Archives/edgar/data/1637459/000119312515126301/d898418ds4.htm

 

[vince]

https://www.cnbc.com/2019/02/25/buffett-says-berkshire-hathaway-overpaid-for-kraft-following-last-weeks-stock-plunge.html

 

If Buffett says he overpaid at ~$30/sh cost basis years ago, think about how far off $70/sh a couple of years ago was.

 

I never understood the valuation at that point. I assume a Buffett/Berkshire halo effect contributed to the overvaluation.

 

I will start off by saying I was dead wrong on this one....big time.  I still dont believe the price was unreasonable at 85-90 IF you believed that they would likely pull off another huge acquisition!!! and boy oh boy they almost did.  The enormous value that would have been created would have made the recent pain much more tolerable and I think it's obvious they saw their mostly food brands deteriorating and Unilever's non food brands would have been a fantastic fix.  I dont think its a coincidence either that Buffett left the board after the failed Unilever offer but before the shit hit the fan.  Maybe I'm just plain wrong all along but it sure felt like they were creating enormous value (i'm not just talking about stock price increases) and Unilever would have been a huge synergy/cost saving/value creating merger.  I know there will be people that disagree with me and they will have every right to cause they disagreed with me all along and they were right. 

[scorpioncapital]

In a case like this I don't see why Berkshire is not more aggressive to sell down in the open market...

Also, it was a bit apathetic by Buffett to say he didn't like hostile takeovers and cancel the thing. I mean, if you thought your goose is cooked, maybe best not to dislike hostile takeovers so much ;)

 

 

[LightWhale]

In a case like this I don't see why Berkshire is not more aggressive to sell down in the open market...

 

They would have to make it public within 2 days of starting to sell, which would likely cause the stock price to crash, and since their chunk is huge, that would mean selling most of it at far lower prices.

[mwtorock]

Warren's cost of capital is very very low. Even if just consider the dividend alone, he would pretty much keep the investment, unless he sees a real danger of 0.

[ander]

In a case like this I don't see why Berkshire is not more aggressive to sell down in the open market...

Also, it was a bit apathetic by Buffett to say he didn't like hostile takeovers and cancel the thing. I mean, if you thought your goose is cooked, maybe best not to dislike hostile takeovers so much ;)

 

 

 

Buffett said in the CNBC interview that there was not enough liquidity for him to be able to sell down - basically impossible to move a block as large as his investment size. And the daily value traded is only a fraction of his total holding. He did clearly say if it was a small position or $10 million or something, he would have sold it.

[SHDL]

Buffett said in the CNBC interview that there was not enough liquidity for him to be able to sell down - basically impossible to move a block as large as his investment size. And the daily value traded is only a fraction of his total holding. He did clearly say if it was a small position or $10 million or something, he would have sold it.

 

Right, and I think this was the first time I heard him say anything like that.  For me the obvious thing to do was to short just enough KHC to offset the position I indirectly own through BRK. 

[rb]

This thing keeps on dropping. At some point it becomes a buy right?

[Spekulatius]

This thing keeps on dropping. At some point it becomes a buy right?

 

I personally will get interested at 9x EBITDA, which would be around $26 , I think.

[aws]

I'd want to see another deal done on favorable terms.  If they can sell off a less than desirable asset for significantly more than the implied value of the remaining company that would be quite appealing.  The small Indian deal was done at great metrics of 4.2x sales and 20x EBITDA, but I'm sure cut growth prospects.  While the Canadian deal which is probably more representative of what they have left was done at 2.89x sales and an unspecified multiple of EBITDA.  2.89x sales values them at around 76 billion EV or a bit under $38/share.

[Kaegi2011]

I think a lot of the comments here capture the issues facing the company.  I want to chime in with a few bits and pieces in hope to further the discussion.

 

Marketing / brand value - this has been noted here by many other posters, but I thought this is well known at this point.  As a Millennial I can tell you that it's highly unlikely that I will pay for a Kraft product in the future, especially for my family.  Two quick articles to highlight the point:

 

https://www.forbes.com/sites/andriacheng/2018/10/17/17-billion-this-is-how-much-sales-major-cpg-brands-have-lost-to-upstart-labels/#45ad30e26d35

https://www.catalina.com/news/press-releases/catalina-mid-year-performance-report-finds-challenging-market-for-many-of-top-100-cpg-brands/

 

Food landscape - not sure how many people have looked at the financials of grocers but it's pretty atrocious.  The scaled one run on 1-1.5% net margins, operate largely inflexible boxes, have 40-50% of their products self destruct on a weekly basis, with lowest cost labor they can find, and relatively minimal overhead.  So if traffic or volume declines, what could you do?  You can't reduce inventory (drives further decline), you can't restock shelves less b/c a missed revenue is worse than the labor cost, you can't shrink the box, you can't raise prices (I'll get to competition in a sec), there's only so much to cut at overhead level... So what do you do as a grocer?  I think a lot of these guys will go bankrupt over the next 10 years.

 

Before a bunch of them go away, they're going to milk the CPGs for all its worth.  I've done a directional analysis of the total profit pool for packaged goods, and somewhere between 40-70% of the total profit (consumer price less total cost [note total cost is not CPG cost]) flows to the brand.  That leaves very little for the retailer, the manufacturer (sometimes same as the brand owner), the farmers, the suppliers of ingredients and packaging.  So my hypothesis is that the retailers will squeeze the CPGs for this money, because the alternative is going out of business.

 

Which then gets me to Wal Mart.  They have been doing a fantastic job over the past few years.  A few years ago they realized they needed to reorganize to fight Amazon and the super discounters (Lidl/Aldi who's been kicking their butt in Europe), which means reinvesting in the store, more associates, and better pricing.  What's been funding these initiatives is kicking the crap out of CPGs.  Remember when Campbell's could not negotiate the soup season deal with Wal Mart and the stock dropped like 15% during earnings?  That was a public warning to anyone who still thinks the leverage is still on the brand side.  All of their buyers have gone through negotiation school and their value demands (cheapest price 80% of the time and beating average market price by 15% - or something like this, don't quote me on the exact numbers) are real - you either play ball or someone else would, so even if you're the #1 brand you bend over.  They're also leapfroging the competition with e-commerce and omni-channel execution.  Given the investments into the store experience and the value demands, is it any wonder they're taking share and growing much more than their peers?

 

Net net, I think the entire ecosystem is unhealthy.  You either play the dollar stores, Wal Mart, Costco, or don't play at all.  The small food brands that are challenging the Krafts of the world generally don't have the scale or the margins to do well. 

 

SEC investigation - this one caught my eye.  It's curious the announcement came 4 months after the fact, and that Berkshire was not told of it until recently (Buffett interview).  The really interesting bit is that SEC is somehow involved... If the company discovered an innocent mistake I think this would be handled differently, and there would not be an investigation with an outside counsel.  Mistakes happen, hopefully infrequently, but they do happen, but for 25mm and a company of this size does this not seem out of character to get SEC/external counsel involved?  So this makes me wonder if there was a whistle blower who alerted the SEC, and if so, then it implies it was something nefarious rather than a mistake, which then makes me wonder... is there ever just one cockroach?

 

Leverage - At this point the company is 4.5x levered, so quite high even for a "stable" company.  What's been interesting is that they continue to have a dividend at all.  Actually I was curious to see that they continued the dividend since the merger.  If 3G wants to continue the acquisition spree, wouldn't the best use of that cash be to de-lever and re-lever for the next deal?  When it was 90 bucks a share, who owned it for the dividends (at high teens EBITDA valuation)?  In hindsight that would have been the prudent thing to do.  Now they're stuck because until they de-lever, the rating agencies are unlikely to give them a pass on another huge deal where they would re-lever.  From a ratings perspective they've already lost a decent amount of credibility. 

 

Next deal - At this price, their stock can't really be used for any deal.  So this may be good for Berkshire / 3G in that they could come in with a big check and underwrite a deal and get sweet terms, but as a shareholder it'll be pretty dilutive, so basically the same outcome as using shares as remuneration in a deal, just that the value flow is to BRK / 3G as opposed to the other side.  Not sure how to get around this problem...

 

3G - I'm surprised by the reaction in the media - everyone bashing 3G for cost cutting, etc.  Given my view of the world, they should be cost cutting, as should be everyone else.  If anyone thinks that spending hundreds of millions on marketing to revive Kraft is a value creating endeavor I'd be very happy to take the other side of the bet.  All of the big guys are pretty much in the same situation, so I guess they're all too happy to laugh at the shortest midget...

 

Is it clear that I'm not long the stock?  :)  In hindsight buying puts would have been so obvious when it was 90 bucks...

 

[Okonomen]

The fact is that as soon as they have delevered just slightly, they will try to do another huge M&A deal to reach their desperate desire for growth. Due to this fact alone I will probably always stay away fromthis company, cause it is terribly managed

[Gregmal]

I've personally never seen the appeal to these type of companies. Yes, they have iconic brands. Yes, they have some products that every American uses. But the bottom line is that over the past couple decades the gap between no label brands and these type of brands has all but disappeared. One could literally retire on the money saved from switching from Kraft/Heinz type products to generic. The only way to combat the price discrepancy, is to lower prices. Not good for shareholders.

 

I love Kraft BBQ sauce. But I only buy it when its on sale and at the same prices or even cheaper than the generic. Normal price is about $2.39. Sale is 4 for 5. Generic is between $1.25-$1.49. I see the same shit going on with pretty much everything in the grocery store, especially cereal. Who is paying $4.49 for a box of Cheerios anymore when the store brand is twice the size and $2.79?

 

The times are changing.

[wabuffo]

not sure how many people have looked at the financials of grocers but it's pretty atrocious.  The scaled one run on 1-1.5% net margins, operate largely inflexible boxes, have 40-50% of their products self destruct on a weekly basis, with lowest cost labor they can find, and relatively minimal overhead.  So if traffic or volume declines, what could you do?  You can't reduce inventory (drives further decline), you can't restock shelves less b/c a missed revenue is worse than the labor cost, you can't shrink the box, you can't raise prices (I'll get to competition in a sec), there's only so much to cut at overhead level... So what do you do as a grocer?  I think a lot of these guys will go bankrupt over the next 10 years.

 

I don't think you understand the grocery business.  Many of the larger grocery chains have dominated their markets for close to 100 years in some cases.  Once a grocer gets to scale in a particular city or region, they are remarkably difficult to displace.  That is not the sign of an atrocious business.

 

Sure some of them get mismanaged and overly-acquisitive grocery chains sometimes get into trouble with debt, but they do have some durable advantages.  Many attempts have been made at on-line groceries and they have been either outright failures or very limited in their success.

 

I think you need to do a deeper dive into the economics and competitive advantage of large well-run self-distributing grocery chains. Even Amazon has not been successful (so far) in their attempts at grocery.

 

wabuffo

[wabuffo]

But the bottom line is that over the past couple decades the gap between no label brands and these type of brands has all but disappeared.

 

I think this is the key mistake made by KHC under 3G - they got aggressive with pricing - perhaps too aggressive.  And cutting promotions and trade spending is the same as raising average pricing.  People will switch to private label if price gaps become too large.

 

The good news is this is easy to fix.  KHC makes such tremendous returns on tangible capital that the price gaps can be repaired and the volume will come back.  It doesn't help 3G/Buffett with their unrealistic margin expectations related to their purchase price - but they have now faced that mistake so they can get back to managing the business for the long-term.

 

I think these obituaries about branded food companies are way too pre-mature.  These businesses are capable of producing excellent long-term margins but you can't stretch them beyond what they are capable of doing.

 

wabuffo

[Read the Footnotes]

Who is paying $4.49 for a box of Cheerios anymore when the store brand is twice the size and $2.79?

 

Good question, but . . .

 

1. I think you are expressing a personal bias.

2. I have the same bias.

3. If this board is full of value investors, the board is probably full of people with the same bias.

4. If you're NOT trying to be logical and cheap with your investments, go somewhere else. COB&F is probably the wrong board for you.  :D

 

Not everyone thinks or behaves like we do. Whether any of this is relevant to the company's future is a different question.

[Read the Footnotes]

 

Food landscape - not sure how many people have looked at the financials of grocers but it's pretty atrocious. 

This brings back painful memories for me. One of my first investments would have been a grocer had someone not convinced me that all grocers are horrible businesses and grocers are always horrible investments at any valuation.

 

I missed out on a ~300% return in less than a decade.

[Gregmal]

Who is paying $4.49 for a box of Cheerios anymore when the store brand is twice the size and $2.79?

 

Good question, but . . .

 

1. I think you are expressing a personal bias.

2. I have the same bias.

3. If this board is full of value investors, the board is probably full of people with the same bias.

4. If you're NOT trying to be logical and cheap with your investments, go somewhere else. COB&F is probably the wrong board for you.  :D

 

Not everyone thinks or behaves like we do. Whether any of this is relevant to the company's future is a different question.

 

I agree, but... This board is probably more concentrated in terms of people who have the means to just grab the big yellow box of Cheerios without thinking twice, without noticing the impact on their bank accounts. Where does one draw the line? It depends on income. Maybe a $499 product people here wouldn't touch if the same thing was available at $339 elsewhere. But are there really people making six figures who deprive themselves something over $1?

 

If you look at the macro environment, I think the convergence of many headline social issues has squeezed these types of businesses. Wage growth hasn't been tremendous. Cost of living has crept up. So I dont think its a crazy assumption to make, that the consumer today is more price conscious, not to mention, has more options than ever before, and this directly impacts businesses like KHC. The every day, normal person, living on the average wage, is not going to become an incrementally larger buyer here, ever again, unless prices fall significantly. Rather, it will be the opposite. In fact I'd even argue one of the biggest selling points here, much like with Sears back in the day, was influenced by your parents, or friends, or colleagues behavior. How many people shopped at Sears in the 80's and 90's because every time Dad needed something he ran to Sears? In 2010, no one shopped at Sears because, no one shops at Sears. I remember in the 90's, every restaurant had Heinz Ketchup. So did every refrigerator. I dont know, but I'd gander that isn't the case anymore, and these trends, at least from what I've seen, are nearly impossible to reverse.

 

Frankly these businesses, same goes for Campbells and Coca Cola, remind me of old school retailers like JCP, Macy's, and SHLD. The underlying issues that plagued those businesses, have been, and continue to, plague these businesses. Melting ice cube, secular decline, whatever you want to call it; bad investment idea is what I tend to lean towards right now.