KHC - Kraft Heinz Co.

[Spekulatius]

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

 

From Buffett’s interviews it is clear that KHC Not just got overagressive  just on pricing , they apparently started to bully their customers, namely the grocery chains. I greenits still a good business, make like $6B on $7B of tangible capital. It’s just not good enough to justify $100B of intangible capital any more. I also think that KHC apparently acknowledges the problem and adjust the pricing (as volumes are rising while margins are falling). This should in the long run defend the remaining brand value.

 

As far as Groceries are concerned, there seem to be local oligopolies in every local market where I lived. Here in the Boston burps there is Market Basket and Wegmans (both are private) and Long Island we had a higher end local chain, that had an amazing deli and fish counter (very popular in LI) and the best cheese selection they I have seen beyond French hypermarches anywhere. I don’t think larger chains can touch those, as they seem to have carved out niches in both market segments and regions that are very hard to replicate and compete against. I think home delivery is one trend to watch out for disruption in this market.

 

Anyways, I am watching KHC as I think it might become interesting at some point. I would be a buyer at 9x EBITDA assume everything stays about equal, as I think this would give a margin of safety, even if it is a slowly melting ice cube.

[Read the Footnotes]

But are there really people making six figures who deprive themselves something over $1?

 

I googled "Wilbur Ross Sweet'N Low" for you:

 

https://www.vanityfair.com/news/2018/08/wilbur-ross-stole-money-from-colleagues-sweetn-low-from-restaurants

 

I was about 95% just trying to be funny and make fun of myself and anyone like me in my previous post, but if your argument is that KHC and others have had trouble passing along costs or price increases, then I agree the data does seem to support that. There are other things that journalists, "analysts", commenters, and pundits have said that don't seem to be supported by by data or the financials.

[DooDiligence]

This is a great discussion & my superficial takeaways are:

 

Frugal behavior is not universal & I tend to blow businesses off just because I wouldn't respond to their offers.

 

Blinding by bias against a particular industry. One example for me is airlines which may have become a more stable (infrastructure) investment IF oil & labor will cooperate AND consumers don't balk (is there any pricing power in an inflationary environment?)

 

A bad investment at one price may offer a decent return in a fire sale.

 

Extrapolating the future of CPG is hard.

[rb]

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.

As an anecdote regarding Cherrios. I know someone who buys Cherrios - the branded stuff. He's probably not the cheapest guy in the world but he's definitely the cheapest guy I know - and I know plenty of cheap people. His wife is pretty cheap as well.

 

So this guy pays up for the branded cereal. Why? Because it's not that expensive. Because he has cereal for breakfast, breakfast is the cheapest meal of his day. And he likes cheerios. If he were to switch to the generic stuff what he's actually save is what? About 15 cents per meal? That's not a lot of money. So even this cheap guy sticks with the branded stuff.

 

I'm not nearly as cheap as this guy but I've switched to generic ketchup from Heinz. Did I do it for the money? Nope. I did it because of a combination of Trump's NAFTA nonsense, what seems like KHC's absolute refusal to make a low sugar and low sodium Ketchup, and some other nonsense that Heinz pulled in Canada.

 

The generic stuff costs about a dollar something less per bottle. I use a bottle every 4 months or so. So I'll save maybe 2 USD per year by going with the generic. The thing is that switching wasn't cheap. It cost me some money and quite a bit of time. When you take into account all that went into the switching decision it was definitely a negative NPV project. The savings from price just aren't big enough.

[Gregmal]

That Wilbur Ross thing is disgusting. I know a few people like that. It is a sickness. A mental disorder being that petty and unaware of general context.

[Spekulatius]

That Wilbur Ross thing is disgusting. I know a few people like that. It is a sickness. A mental disorder being that petty and unaware of general context.

 

Some thing is wrong with the society when people like this get so far.

[Kaegi2011]

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

 

At some point during the last century, I'm sure it was a decent business - tailwind on population growth, pricing power, development of suburban areas means new boxes, etc.  All of those factors applies more broadly to retail, but the world has changed.  So maybe I should have been clearer - I'm talking about them as businesses right now, and not seven decades ago after the war.  So I mentioned reasons why they are not in a great position today w/r/t the levers they can pull to improve profitability, and why they might be able to sustain themselves for a while longer by extracting margin from CPGs, but longer term I think only the top guys will survive, along with Costco, hard discounters, and dollar stores, as mentioned previously. 

 

Here are a couple of articles on the smaller guys not surviving (but have local scale that you talked about).  There is also a Wiki page of all the grocery stores that's gone bankrupt if you're curious. 

https://www.bloomberg.com/news/articles/2018-03-19/supermarket-casualties-begin-to-pile-up-in-amazon-fueled-battle

https://www.washingtonpost.com/news/wonk/wp/2018/03/22/the-amazon-whole-foods-era-of-grocery-just-claimed-its-first-victims/?utm_term=.45b83df28fcd

 

So I acknowledge that they have some positives, as do almost all businesses, and perhaps atrocious was too strong of a word, but I stand by my contention that they are structurally going to get weaker going forward, and only the strongest will survive. 

 

[Kaegi2011]

 

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.

 

You're putting words in my mouth. 

 

1) I did not say that all grocers are horrible businesses, my comment was a general one on the grocery industry.  I specifically called out dollar stores, hard discounters, WMT, Costco, and the large players are beneficiaries of share being lost by traditional grocery stores. 

2) I definitely did not say grocers are always horrible investments at any valuation.  Of course everything has a price. 

3) You might also have missed out on a much larger return during a much shorter period on Netscape during the 90s, for example, but that does not prove that it's a great business or not. 

 

If your contention is that it's a good business, lay out the reasons why it's so instead of putting forth a strawman argument. 

[Kaegi2011]

 

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

 

It seems like the discussion is going to extremes.  If I started that with my word choice, I apologize.  I don't think these businesses will die in the near future. 

 

Having said that, the market and valuation is highly sensitive to growth, so at the margin, things are not good.  It doesn't imply that CPGs can never be good investments but the risks have to be appropriately priced.  So what I tried to point out is that at the margin, brands are declining.  This has been happening for at least five years, if not longer.  Look at the link I quoted previously - 90 out of the top 100 brands are losing share in the US, 62 are declining.  These businesses used to be 1-2% volume, 1-2% price, and low double digit EPS growers.  That growth algorithm is long gone, in my opinion. 

[bizaro86]

I tend to not get my groceries delivered at home, but often stay in condo type accomodation on vacation, and tend to get groceries and make at least some meals (always breakfast).

 

I noticed that when I shopped online for delivery, I was more likely to buy branded goods because I couldn't see or touch the generics and it made it harder to compare.

 

Maybe I'm an anomaly, but I think it's possible grocery delivery getting a larger share might be a potential tailwind for brands.

[Read the Footnotes]

 

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.

 

You're putting words in my mouth. 

 

1) I did not say that all grocers are horrible businesses, my comment was a general one on the grocery industry.  I specifically called out dollar stores, hard discounters, WMT, Costco, and the large players are beneficiaries of share being lost by traditional grocery stores. 

2) I definitely did not say grocers are always horrible investments at any valuation.  Of course everything has a price. 

3) You might also have missed out on a much larger return during a much shorter period on Netscape during the 90s, for example, but that does not prove that it's a great business or not. 

 

If your contention is that it's a good business, lay out the reasons why it's so instead of putting forth a strawman argument.

 

I did not mean anything other than exactly what I said. It brings back bad memories.

[Read the Footnotes]

That Wilbur Ross thing is disgusting. I know a few people like that. It is a sickness. A mental disorder being that petty and unaware of general context.

 

Some thing is wrong with the society when people like this get so far.

 

I guess I unintentionally used an example that was overkill to try to make a simple point: For some people, old habits die hard.

[Castanza]

Any news or opinions on this? Seems to have bottomed out around $32. Premiums are a tad steep, and I think some news would be worth waiting for, but some 2021 LEAPS are looking more and more attractive as this $32 bottom continues to solidify. Opinions?

 

https://seekingalpha.com/news/3462872-kraft-heinz-confirms-accounting-delay

 

 

[Txvestor]

Under 30 today. Delayed 10-Q.

[ander]

Big reaction for delayed 10-Q given the news that has been announced or is the concern that there's another shoe to drop?

[no_free_lunch]

I am with you Castanza.  Given the debt load I would only look at this one via Leaps.

 

It would be nice to see them drop the dividend as a starting point.  I can't see how they justify it.

[Foreign Tuffett]

I am with you Castanza.  Given the debt load I would only look at this one via Leaps.

 

It would be nice to see them drop the dividend as a starting point.  I can't see how they justify it.

 

I think the plan is to continue the dividend (which was recently cut) and reduce debt via asset sales.

[BG2008]

Does anyone remember the last time when a widows and orphan stock like KHC lost the equivalent of $90 to $29 in two years?  This is kind of nuts to see in real time. 

[Spekulatius]

Does anyone remember the last time when a widows and orphan stock like KHC lost the equivalent of $90 to $29 in two years?  This is kind of nuts to see in real time.

 

GE didn’t do much better. KMI fell from $35 to $15. When you look at banks, many of which were considered stalwarts and dividend stocks before the financial crisis, you will find plenty of them who did worse.

 

[ander]

Kraft Heinz (KHC) shares closed down 6.6% Tuesday to $29.06 after reports of weak trends in food sales based on scanner data in the four weeks ended in mid-May.

from Barron's re: the price move down.

[valuedontlie]

this business hasn't generated TTM cash from ops >$3bn in nearly 7 years... that's before capex... on a $35bn market cap... before figuring another $30bn+ in net debt...

 

EBITDA isn't a very useful figure if you can't turn $1 of EBITDA into 15-20c of operating cash flow...

 

 

[TwoCitiesCapital]

Does anyone remember the last time when a widows and orphan stock like KHC lost the equivalent of $90 to $29 in two years?  This is kind of nuts to see in real time.

 

Debt has a funny way of doing that to you

[petec]

this business hasn't generated TTM cash from ops >$3bn in nearly 7 years...

 

Are you adjusting for the working capital anticipation recorded in financing cash flows?

[Foreign Tuffett]

Isn't a big part of the story here that KHC got rid of experienced employees and replaced them with 20 somethings with minimal relevant experience? Take, for example, the following quote from several years ago:

 

"When you compare this company to other companies in the industry, I don't think there are many places where you could see 24-year-olds managing hundreds of millions of dollars of brands three years out of college."

 

https://www.chicagotribune.com/business/ct-kraft-heinz-culture-0528-biz-20170527-story.html

 

There's a reason for that, right? Even a very bright and motivated 24 year old is poorly equipped to grow a huge CPG brand if they lack relevant knowledge and experience. I feel like the 3G dominated C-suite has lacked respect for domain specific expertise because (1) it felt that the 3G management model could be applied to nearly any industry and (2) it, itself, lacked a CPG background (3) a belief that the company's products were annuity-like.

 

This dynamic explains why so many KHC Glassdoor reviews expound at length about long hours, inexperienced coworkers, and inefficiency. Employees are spending their time reinventing the wheel instead of relying on best practices, etc.

 

I believe the incoming CEO was recently quoted as saying that KHC's brands need to be "rejuvenated." So at the very least he recognizes the problem that needs to be solved.

 

 

[Jurgis]

Isn't a big part of the story here that KHC got rid of experienced employees and replaced them with 20 somethings with minimal relevant experience? Take, for example, the following quote from several years ago:

 

"When you compare this company to other companies in the industry, I don't think there are many places where you could see 24-year-olds managing hundreds of millions of dollars of brands three years out of college."

 

https://www.chicagotribune.com/business/ct-kraft-heinz-culture-0528-biz-20170527-story.html

 

There's a reason for that, right? Even a very bright and motivated 24 year old is poorly equipped to grow a huge CPG brand if they lack relevant knowledge and experience. I feel like the 3G dominated C-suite has lacked respect for domain specific expertise because (1) it felt that the 3G management model could be applied to nearly any industry and (2) it, itself, lacked a CPG background (3) a belief that the company's products were annuity-like.

 

This dynamic explains why so many KHC Glassdoor reviews expound at length about long hours, inexperienced coworkers, and inefficiency. Employees are spending their time reinventing the wheel instead of relying on best practices, etc.

 

I believe the incoming CEO was recently quoted as saying that KHC's brands need to be "rejuvenated." So at the very least he recognizes the problem that needs to be solved.

 

It's cool explanation, but really it's yet another post-factum rationalization of what happened.

 

If they were successful, everyone would say "Look, they replaced dinosaurs with McKinsey kids and succeeded. Everyone should do that".

Now you say "Look, they replaced experienced people with kids with no experience and failed. Nobody should do that"

 

There are CPG companies staffed with dinosaurs experienced people that are not doing great either.

 

Although you are right that what they did did not succeed in this particular situation.  ;)