When it rains, it pours. That’s the phrase that springs to mind whenever I think about Kraft Heinz (KHC) 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 to certain brands. That came alongside a SEC investigation into the company’s accounting polices and a 36% dividend cut. All said and done, those latest blows cost the stock a further 30% of its value.
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. I mean, not that much has actually changed in terms of the underlying business. Kraft should make around $3.5b this year, basically unchanged on what it earned a couple years back. The big difference is that the stock now trades on a PE of 10 rather than 30. An expansion back to, say, 12-13x earnings would add 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, or circa $3b in cash terms. This goes without saying, but when you spend most of your profit on cash dividends then not much is left for stock buybacks, acquisitions or to tackle debt.
Speaking of debt, we know that Kraft has a boat load of it – currently around $30b net of cash to be precise. The annual dividend – now $1.60 per share – frees up around $1b for debt reduction. That might not sound too impressive on its own, but with the company looking to raise cash by offloading weaker brands the end result could be more more significant. As a shareholder, debt reduction would be my number one priority going forward.
The business is probably more stable than commentators have given it credit for. For instance, I have seen Kraft Heinz compared to General Electric on more than one occasion these past two weeks. 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. It has been more a case of general stagnation and not achieving the double-digit growth targets envisioned back in 2015.
Upside scenarios don’t really require much growth either. 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, we are looking at double-digit shareholder returns here. Anything better than that – even just in the 4-5% EPS 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.
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