Kraft Heinz: The Road Ahead

by The Compound Investor

Kraft Heinz (KHC) stock last featured on the site back in February. The Heinz Ketchup and Philadelphia maker traded for around $27 per share back then, with that price backed up by FY19 adjusted profit of circa $2.85 per share. That may look cheap, though most folks know the company comes with a hefty amount of baggage. Profit has fallen in recent years, while its balance sheet is lumbered with a significant amount of debt. Indeed, the ratings agencies had just downgraded its debt to junk status when that article was published.

Much has obviously happened since then. I guess the best place to start is with recent operating results given that we have two fresh quarters of figures. The COVID-19 pandemic has had an interesting, and positive, impact on the firm. Its foodservice business – i.e. sales to away-from-home establishments – has understandably taken a big hit. That has been more than offset by increased sales to households via the usual retail channels. Global net sales clocked in at $12.8B over the first half of the year, up around around 3.5% on the year-ago period. Organic net sales rose 7% over the same timeframe (i.e. net sales after stripping out foreign currency movements and the impact of business divestitures).

On the profit side of things, adjusted EBITDA for the period came in at $3.21B. That was up around 6% from the $3.03B it generated in the year-ago period. Adjusted profit per share fell to $1.39 from $1.44, though this includes a 10¢ per share impact from higher taxes and asset divestments. The company generated enough surplus cash to cover its $975M dividend obligation with change. Net debt fell to just over $26B at the end of 1H20, down from around $27B at the end of last year.

Outlook

Previously, I had hoped this year would represent the nadir for Kraft. It was guiding for circa $5.7B in EBITDA and $2.5B in free cash flow pre-pandemic. Because COVID has had a positive impact on the business, Kraft actually expects mid-single-digit adjusted EBITDA growth this year. By my count, that means somewhere in the region of $6.4B for FY20 as a whole. The company sees leverage falling to 4x by year-end as a result. I make that equivalent to around $25.6B in absolute terms assuming my math is right.

Anyway, it looks like the business is finally starting to stabilize. Analysts see Kraft posting a net profit of just over $3B next year. I have that equivalent to around $2.50 on a per-share basis. With the company set to maintain its $1.60 per share annual dividend, we are looking at another billion dollars or so in retained profit next year for debt reduction. Moreover, it recently announced the $3.2B sale of certain cheese businesses to Groupe Lactalis. Kraft will use the proceeds to further reduce net debt when the deal closes in the first half of next year. It will cost Kraft around $265M in terms of annual EBITDA, though it should make something back on lower interest expenses from reduced debt levels.

On a longer-term basis, management recently released financial targets during its 2020 Investor Day. They are fairly modest, but bear with me for a moment. These targets include 1.5% annual net sales growth, 2.5% annual adjusted EBITDA growth and 5% adjusted earnings per share growth. The shares currently change hands for just over $29 apiece at time of writing. Quick math suggests a forward earnings yield of around 8.5%, with the prospect of mid-single digit growth on top. In the meantime, the shares continue to offer a 5.5% cash dividend yield at their current price. The company still has a long road ahead of it, but hopefully one that is slightly less bumpy for shareholders.

Note

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