When we see a company such as Kraft Heinz get hammered so much, we usually think that it’s the grocery business itself that is to blame. This has been all by their own hand.
Given the sheer ugliness of Kraft Heinz’s stock over the last few years, and we might want to try to explain this by pointing to what we believe is the decline in the packaged grocery business. Food spending is the staple of staples, as we all need to eat, and in developed nations, we spend a lot of money on food, so the food business is and always will be strong overall.
Whether or not people buy the food that you are selling is another matter though, and given its declining sales, people have come to prefer other options to a meaningful degree over what Kraft Heinz makes. It doesn’t matter whether they are now choosing other people’s brands, or shopping at stores that doesn’t carry yours, or even eating restaurant food instead, if they are switching, you are dropping the ball and get what you deserve.
There’s no question that declining sales has played a big part in the demise of this company. Perhaps demise is way too strong of a word to use, as they are still expected to make a good profit in the foreseeable future, even though earnings are forecast to decline over the next few years. They at least will be making money, and they’ve had years where they didn’t, like 2018 as well as 2014 and 2015.
The impact of this could even be describe as pretty modest compared to some other distressed stocks, but when your business is shrinking rather than growing, that’s more than enough to scare people away from your stock, and that is what has happened.
People see the stock tumble and look to the business to explain it, although we need to make the proper distinction between a company’s recent business results and its stock price. The stock price looks well beyond these results into the future, because when investors look to buy or even hold it, they aren’t really that worried about last quarter or next quarter, they are also very much focused years ahead.
When we see big divergences with fundamentals and stock prices, this is one of the big reasons. What happens with the company is also just part about what affects its stock price, whether now or years from now, as there are also macro factors to account for, how stocks in general are seen to be headed, and these are powerful trends that drag most stocks in tow on the way up and especially on the way down.
We’ve been in a bull market throughout all of Kraft Heinz’ existence, as this is a stock that has only been around since 2015 and both the economy and the stock market has done very well since. This is a case of the company dragging the stock down, not so much due to what has happened or is happening but what is likely to come in the future.
The skies started to darken for Kraft even before the merger with Heinz, when in 2012 they spun off their snack business, and Mondalez International was born and sent off on its own with its own stock.
Kraft Kicks Out Their Strong Business and Takes on More Weakness
To show how these two stocks have been moving in opposite directions, back in mid-February 2017, Kraft Heinz broke above $91 a share, with Mondalez around $44. Since then, Kraft has lost over $60 a share while Mondalez is now over $50. While Mondalez hasn’t exactly performed that well, they at least have gained since.
Spinning off Mondalez was a mistake on several fronts, and one of them has been with Mondalez representing the more progressive side of the business, with the Kraft brand being more of a classical company, which you get called when your biggest sellers are the same products that your grandparents brought.
Two years after the spin-off, the leaner Kraft company actually lost money, and lost money the next year as well. The mistake of this was splattered all over walls like you see in food fights, so Warren Buffett’s Berkshire Hathaway, which already had a big stake in Kraft, teamed up with Brazil’s 3G Capital to merge the company with Heinz.
This formed the fifth largest food business in the world, although the marriage was between two crusty old companies that haven’t done all that much to reinvent themselves since Kraft cheese and Heinz ketchup were born.
The lack of innovation and product support ended up doing most of the damage here. This was all made worse by this merger, and it wasn’t the merger itself that did it, it was the way that 3G Capital tinkered badly with the business model.
3G Capital is world famous for its cheapness, as they buy a company and then look to slash everything. This happened at Kraft Heinz as well. Kraft was already the cheapest kid on the block before the merger, spending way less than any of its competitors, including Heinz, on marketing and new product development.
After the merger, Kraft Heinz’ spending on marketing and product development dropped to less than the two companies had spent together. This was the area that was hurting Kraft the most before the merger, which was made a lot worse after it. This is what is called going from the frying pan into the fire.
This explains what happened to the company so well that there isn’t even much more to know. It’s not that things aren’t so bad now, but things are shrinking, and that’s a very bad thing for a stock.
To show how stock prices are focused on more than just the present, we only need to look at Kraft Heinz’ 2017 results. In the previous 5 years combined, Kraft Heinz earned a total of $8.16 a share. In 2017 alone, they earned $8.91 a share. You would think that these fabulous earnings results would have their stock soaring, or at least not going down.
Kraft Heinz stock lost 12% that year though, and it wasn’t the market bringing it down, as the market was up 21% that year. That’s underperforming the market by a full 33% in a year where your company killed it.
This actually makes sense, as investors weren’t just looking at 2017, they were looking at what they perceived to be the company’s future, and how poorly they were positioned for it. It turned out that they were right, and if anything, they underestimated how bad things were that year.
Companies Need to Innovate or Slowly Die, and Kraft Heinz Has Chosen the Latter
The prepackaged food business has really undergone a lot of changes over the past few years, and this change is accelerating each year. While there has always been a need to improve or fall behind, this has become more and more the case with each passing year now. Kraft Heinz is very much stuck in the past, the distant past in fact, and it is because they are so unwilling to spend enough on their future that is behind this failure to adapt.
The market knew this in the earlier days of the merger, and priced it in. It has been priced in more and more as the stock has lost two thirds of its value in less than three years. The future does not look so bright for Kraft Heinz right now, and this is why their stock trades around $30.
This plunge has put the yield up on their dividends, which they continue to pay out even with the company struggling, and this is an excellent case of this money being much better spent elsewhere. They have cut costs and spent too little on their brands when they should have been spending more instead. This dividend cash is sorely needed by the company, especially given how much debt that they have, and especially due to how far behind their brands have become due to neglect.
Kraft Heinz should know better than anyone how much freshness matters, and they simply have become stale. This staleness has come to affect the value of their assets, which has declined by 20% since the merger. Mergers are supposed to provide for more growth opportunity, not shrink the company by this much.
That’s the fault of the way that this company is managed, and their cheapness even extended to its choice of CFO, where they promoted a 29 year old kid to this senior role who had no experience in the business at all, but he was a partner in 3G Capital and he did come pretty cheap. Cronyism and cheapness are not a desirable combination.
Kraft Heinz’ earnings are only expected to decline slightly each year through 2023, but when a business is heading in the wrong direction like this, and continues to be managed in such a penny-pinching manner, it is no surprise that the stock became as beat down as it has.
It might seem like a value down here, but there are so many other places to put your money that involve actual growth and not decline, and growth are what the good stocks are all about. Kraft Heinz is not in this category and is on the other end of it.
There just aren’t good enough reasons to think that this will improve enough in the foreseeable future to want to be in this stock right now, whether we already are in this stock or not.
If Kraft Heinz is to become an attractive play again, we will need to see them change their management approach to give themselves at least a chance to see their business stop shrinking year after year like it is projected to. We should never hold a stock that is falling behind and the bar needs to be at least high enough to restrict ourselves to ones that are instead growing. Count Kraft Heinz out, for now at least.