Kraft Heinz (KHC) shareholders have been put through the wringer over the past few years. The stock has been an absolute disaster zone in terms of wealth destruction and underlying business results have been poor. To compound matters the company slashed its quarterly dividend by some 36% in order to shore up the balance sheet. On Thursday the troubled food group – home of brands like Heinz Tomato Ketchup and Philadelphia cream cheese – released its third quarter financial results. While not exactly stellar, the good news for long-suffering stockholders is that there are tentative signs that things may be beginning to settle down.
Over the three month period ended September 28th Kraft sold $6.076 billion worth of goods, down just under 5% on 3Q18. At first glance that doesn’t look particularly good, however Kraft is a slightly smaller company nowadays and also had to grapple with the effects of a stronger US dollar. Stripping out the effects of divestments and foreign currency movements results in an organic sales drop of 1.1%. Adjusted earnings before interest, taxes, depreciation and amortization (adjusted EBITDA) dropped 3.2% to $1.469 billion on the same basis.
Adjusted earnings per share came in at $0.69, down 9.2% on the $0.76 posted at this point last year. Wall Street analysts were so pessimistic on Kraft’s prospects that this actually represented a pretty big beat compared to consensus earnings estimates of $0.54 per share.
Digging a little deeper what more can we glean? A couple of things spring to mind. First, volume continues to decline. In other words Kraft literally sold fewer products last quarter compared 3Q18. That trend was marginally offset by the company raising its prices. Furthermore, that dynamic is particularly acute in the domestic market. Volume fell 3.2% in the United States while elsewhere in the world the situation looked fairly static last quarter.
The second point I’d highlight concerns guidance. Put simply, management sees 4Q19 being roughly similar to the third quarter in terms of financial performance. While the third quarter wasn’t exactly brilliant, the numbers are not disastrous either. Another quarter in the same vein would be a small sign that business is starting to stabilize.
Debt, Further Dividend Cuts
The health of Kraft’s balance sheet has been in focus for some time now. The profit collapse investors have witnessed here has been bad enough in its own right. Around $30 billion worth of net debt made it potentially a whole lot worse.
On that note the dividend cut announced earlier this year was a no brainer. At $2.50 per year it was costing Kraft pretty much the entirety of net profit per share. At the moment the stock pumps out an annual dividend of $1.60. Needless to say that appears much more manageable, but is another dividend cut on the horizon? When questioned on the prospect the new CEO had this to say:
But now we are going to a very deep strategic review of the business, understanding how we’re going to see the future performance of the company. And in this analysis, in this review, a capital structure is going to be a very important chapter.
To me that sounds like it could be on the cards. The good news is that debt is indeed making its way down, albeit at a slow pace. At the end of last quarter the company reported total debt of around $30.6 billion. Subtract $2.3 billion worth of cash & cash equivalents and I have net debt at around $28.3 billion; equivalent to around 4.5x annual adjusted EBITDA. By way of comparison at this point last year net debt clocked in at around the $31 billion mark.
Given Kraft raised around $1.2 billion by selling its Canadian cheese business not all of that reduction is a result of surplus free cash flow. As it stands the company probably pumps out circa $1.25 billion after subtracting its dividend bill. Slashing that figure to zero would free up close to $2 billion per annum extra. Time will tell if this is necessary but don’t be surprised if another cut is announced next year. Right now a healthy balance sheet and operational stability take priority over cash distributions to stockholders.
It is a measure of how low expectations here were that Kraft stock jumped after the earnings figure hit the newswires. Before the announcement on Thursday morning the shares stood at around the $28.50 mark. By close of play on Friday Kraft stock was changing hands for around $32.60 per share.
So far the company has generated underlying earnings per share of $2.13 this year. With one quarter left to go in 2019 we could therefore reasonably put annualized earnings per share somewhere in the $2.85 region. On that basis Kraft stock currently trades at around 11x forward earnings estimates. Call that an earnings yield of 9%. Granted, the company is not completely out of the woods just yet. But with signs that business is beginning to settle down I continue to think it represents decent long-term value.
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