When it rains it pours is a phrase that springs to mind whenever I think about Kraft Heinz stock. If losing almost half of its 2015 peak value and contending with sluggish growth wasn’t bad enough, we were then hit with news of a multi-billion dollar write down of certain brands, a SEC investigation into the company’s accounting polices and a 36% dividend cut. Those latest blows cost the stock a further 30% of its value. When it rains it pours.
As bad as things seem I remain cautiously optimistic for a couple of reasons. First of all, let’s be clear that much of the share price decline is ‘value’ based. After all not that much has actually changed in terms of the underlying business. For instance back in 2016 Kraft Heinz made around $3.6 billion in net profit. This year it should make around $3.5 billion. The big difference is that the stock now trades at around 10x annual earnings rather than 30x annual earnings. A gradual expansion back to say 12x-13x earnings adds around 4%-5% per annum to the share price over a five year period.
Secondly, and though it may not feel that way, the dividend cut is a good move. Previously Kraft was paying an annual dividend of $2.50 per share; equivalent to around $3 billion in cash terms. When you make $3.5 billion in annual profit but spend most of that on cash dividends then you don’t have much left to do things like buy back shares, purchase other brands or tackle debt.
Speaking of debt, we know that Kraft has a boat load of it (currently around $30 billion net of cash to be precise). The reduced annual dividend of $1.60 per share frees up around one billion dollars for debt reduction. On its own that might not sound too impressive, however with the company looking at raising cash by offloading some of its weaker brands the end result could be more rather more significant. As a shareholder, debt reduction would be my personal number one priority going forward.
Thirdly, the business is probably more stable than commentators have given it credit for. For instance over the past couple of weeks I have seen Kraft Heinz compared to General Electric on more than one occasion. With all due respect to the latter I think Kraft is far more defensive and stable. Core brands like Heinz Ketchup, A.1. Sauce, Lea & Perrins and Heinz Beanz are so iconic that they are almost indestructible. They are cash cows pumping out stable double digit profit margins each and every year.
Finally, the valuation is now as attractive as it will ever be. From this price any ‘further downside’ scenario rests on profits collapsing. So far that has not happened (more just general stagnation and not achieving the double digit growth targets initially envisioned back in 2015).
Upside scenarios start from just plodding along. After all the stock offers a near double digit earnings yield right now. If profit per share was to grow in line with historic rates of inflation then we are looking at double digit shareholder returns. Anything better than that – even just in the 4-5% earnings-per-share growth per annum range – makes the stock a home run. With ownership of some of the best consumer brands in the world it is worth the risk.