Kraft Heinz Stock Analysis – Let’s go to the store

Contents

Introduction. 1

KHC’s stock fundamentals. 3

KHC’s business strategy. 5

Increasing dividend would make KHC great again. 5

You can’t invest in KHC with Buffett 6

Conclusion. 9

Introduction

I have analysed KHC already in April of 2018, when the stock price was $57. In that video I discussed how the company:

  • Has a significant amount of debt ($29 billion) that becomes a burden as interest rates go up.
  • How KHC’s business is positioned in the middle, with Whole Foods catering to the selective and Lidl the cheaper. Being in the middle is not great today.
  • Higher input costs.
  • Weaker brand as consumer preferences have been changing.
  • Buffett’s ownership.
  • Analysts earnings forecast for $3.83 for 2018.

The following screen shot summarizes the negative findings:

1 the negatives

Source: Sven Carlin YouTube KHC Analysis

And the positive findings:

2 the positives for KHC

Source: Sven Carlin YouTube KHC Analysis

My conclusion was that I would take another look at KHC if it hits $41, as it did hit exactly that with its 52week low in December 2018, which is pure coincidence. However, it is time to look at it again just to recheck what has been going on.

3 price target

Source: Sven Carlin YouTube KHC Analysis

At the current moment, KHC’s stock is a bit higher, but that doesn’t really matter much if the long story is intact. Let’s check the fundamentals.

KHC’s stock fundamentals

4 khc fundamentals dividend

Source: Morningstar KHC Stock Quote

The forward expected consensus PE ratio is 13, this should lead to a 7.69% earnings yield. Price to book is below 1, so this looks like a value investment. Definitely one that would fit Benjamin Graham’s investing formula. However, goodwill is $44 billion and intangible assets are $58 billion. Together, those two make 85% of total assets. Tangible book value is just $7 billion with $7.5 billion in current assets. This doesn’t make it a value investment anymore.

5 goodwill and intangible

Source: Morningstar KHC financials

The liability side looks ok with current liabilities equal to current assets and stable long term debt.

6 long term debt

Source: Morningstar KHC financials

Total revenue is $26 billion with high gross margins that signals it is all about brand with KHC.

7 khc key ratios

Source: Morningstar Key Ratios KHC

What has been suffering are operating cash flows and consequently free cash flows. Cash flows have been suffering because of KHC’s growth business strategy.

KHC’s business strategy

KHC is focused on growth and trying to make a turnaround of the business. I start laughing when I see such a company using the words “innovation pipeline”.

8 turnaround

Source: KHC IR.

Increasing dividend would make KHC great again

Do I see increasing dividends for the long term? Unfortunately not. And this is the key with KHC. I think most investors are still dreaming of what had been going on during the last 40 years, up till this decade with companies that scale globally, see constantly growing revenues and increasing dividends. Those times are probably over but, the best way to analyse a business is to test it, what are KHC’s risks? Competition, commoditized pricing, loss of brand awareness, and weak international traction, so, let’s go to the store.

Check video on YouTube for that part (store starts 5:10)

My store conclusion is that KHC has turned into a cash cow, that will deliver cash flows to shareholders with ups and downs. Not a great investment, but an ok investment at a lower price.

The question is – will people buy more? Is there a moat that will lead to higher earnings, pricing power? 20% of sales come from Wal-Mart, that is under pressure from all the other competitors out there, a little bit from Amazon and Whole foods, a little bit from Aldi and Lidl, a little bit from the new sexy yoghurt invented by this or that influencer and slowly you do not grow, or it costs much more.

Their strategy is growth at all costs, which could even lead to shareholder value destruction, and a PE ratio of 13, is certainly not attractive for me. So, now that KHC is down to $46, was down to $41, I can firmly tell you I am not going to invest in it not even at $30, probably not even at $20 because I am looking for great businesses, that can reinvest their capital at a high rate of return. As for Warren, I think he was a bit biased by his love for Ketchup while Sergio Lehman from 3G managed to convince him the downside is limited, which it actually was for him, but don’t expect miracles there.

You can’t invest in KHC with Buffett

Just a note on why Buffett’s downside was limited, he acquired his stake in Heinz in 2013 but didn’t not pay much money upfront, $4 billion in cash and $8 billion in preferred shares that payed a 9% dividend. No retail investor can make such deals and don’t forget that interest rates were close to zero in 2013.

10 berk source

Source: BRK

Similarly to the Coca-Cola story, Buffett was looking at the stock for a long time before buying:

“This is my kind of deal and my kind of partner,” he added. “Heinz is our kind of company with fantastic brands.” Buffett added, “but I have a file on Heinz that goes back to 1980.”

In 2015, Kraft merged with Heinz and Buffett and 3G bought additional shares by giving $10 billion to Kraft shareholders in the form of a dividend and got equity in return.

9 kraft merger

Source: Kraft Heinz IR

Buffett still owns 27% of the company, which cost him $9 billion in pure cash ($4.25 for Heinz and another $5 for Kraft’s dividend), $8 billion for preferred Heinz shares that gave him two years of 9%, or 3 years. Let’s say the value of that is $8 billion. To summarize, Buffett invested $17 billion to get to 27% of KHC, the market cap is $57 billion thus his stake is worth $15.39 billion. He will probably get $800 million in dividend for that per year now. As 6 years have passed since he acquired Heinz, his invested capital is probably around just $10 billion in the company. I assume he will get that money back over the next 12 years through dividend and this is why Heinz, and later Kraft are a Buffett kind of deal. He will not lose money, there is a chance he makes money, but that chance is not going to lead to great returns in the future. This is ok for Buffett and it also shows what kind of an investor he is. So, Buffett’s entry price, taking into account the dividend going as high as 9% in an 0% interest rate environment, is around $30, not $45.

Conclusion

Consumer trends are always difficult to predict, and were much harder to predict 6 years ago. Buffett invested with a margin of safety which I don’t see at the moment for current investors. A lot can happen which means that practically anything can happen. KHC’s brands are not that strong in the world and preferences are changing. So, we will see. As for me, I prefer different plays, with more value and positive long term trends.

Berkshire stock is better than the S&P 500 – check your portfolio holdings!

BERKSHIRE’s INVESTING MINDSET

Towards the end of Benjamin Graham’s book, The Intelligent Investor, we can find the following advice (Chapter 20 – Margin of Safety):

Investment is most intelligent, when it is most businesslike.

Therefore, to find good investments one must use a businesslike perspective. Only such a perspective will lead to satisfying long term returns.

I compare Berkshire Hathaway (BRK.A) (BRK.B) and the S&P 500 index (SPY) applying a common sense, businesslike perspective. Over the long term, investing based on sound business principles should lead to healthy long term returns. Those principles include:

  • Seeking a high return on invested capital.
  • Buying when there is blood on the streets.
  • Careful risk assessment.
  • Accepting that markets and sectors are cyclical.
  • Being greedy when others are fearful and fearful when others are greedy.

The above, leads me to believe, BRK will outperform the S&P 500 and passive investors should invest more in BRK, than in index funds. In the video I give 5 strong arguments that back my case.

The video summary:

(1:03) Comparison of past performance
(3:44) First argument – S&P 500 and BRK’s investing strategies
(5:32) Index funds can’t copy Buffett’s special deals
(6:27) Second argument – market timing, discipline and cash
(7:31) Return on invested capital
(8:07) Third argument – S&P 500 top 10 holdings in 2018, 2013, 2008 and 1999
(9:26) Fourth argument – Investing in startups, buying high or low
(10:41) Fundamentals – PE, PB, PS
(12:04) Fifth argument – S&P 500 and BRK’s book value growth since 2008
(13:07) Deployment of excess cash
(14:07) Diversification
(14:27) Discussing long term returns

Enjoy the video.

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Berkshire will not do buybacks now!

  • The mania surrounding potential Berkshire buybacks has pushed the stock price up 5% but the effect is already fading.
  • BRK will not buyback stocks at these prices because that would destroy shareholder value.
  • Buffett and Munger are just preparing for what is to come due to the recent changes in accounting policies.

On July 17, Berkshire (BRK.A) (BRK.B) announced that it will buyback shares when the management thinks those are trading below intrinsic value. This created a small mania and the stock jumped 5%. However, as I am writing this, the positive effect on the stock price is already fading. I’ll argue that BRK’s buyback policy change is simply to adjust to the new accounting rules.

From 2018 we can expect much more fluctuation in BRK’s bottom line thanks to the fact that all the unrealized gains have to be included into its net income. This could, in case of a severe stock market crash, where BRK’s stock doesn’t fall as much, create a situation where BRK’s stock price falls less than the book value. In that case the stock would trade at a price to book value above 1.2 but below intrinsic value. Therefore, Buffett and Munger are just adjusting to what might happen so that they can be ready to do buybacks when they think it is smart to do so. They are just adjusting their flexibility to the potential impact of the new GAAP accounting policies.

Now, that BRK’s stock is close to all time highs and the economy is in the late stage of its natural cycle, I don’t think Buffett will get itchy with his cash. I think this is more a preparation for what might come: a stock market crash where Buffett has lots of cash to deploy. He will then see whether it is best to buy other stocks, buyback shares or do both.

Enjoy the video for a detailed explanation using examples from BRK’s annual and interim reports.