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In the summer of last year, I believed that inflation was aiding Kraft Heinz (NASDAQ:KHC) with their reported revenues, yet negative volume trends were concerning.
Amidst these trends, the outlook for 2023 was uncertain, yet the elevated pace of divestments was a thing of the past, with leverage rapidly under control. While the company returned to growth, this was entirely driven by pricing and inflation, with underlying volume trends being concerning.
Over the past year, Kraft Heinz has seen total stagnation in terms of sales, earnings, leverage, as the composition of sales remains dismal, with volumes trending persistently lower. All this is quite concerning, and while current valuations look reasonable, there are simply few green shoots in sight to ignite valuation multiple inflation from here.
A Lost Decade
Since the mega-merger between Kraft and Heinz, a $100 stock in 2015 has come under great pressure. A combination of leverage, elevated pricing and cuts in R&D have weighed heavily on the business and the share price.
In an effort to reduce debt, the company embarked on a number of divestments, including a >$3 billion divestment of the Planters Nuts assets, as well as a similar-sized divestment of its cheese assets.
The combination of inflation and divestments led to sales trending rather flattish around the $26 billion mark from 2016 onwards. With underlying trends being bad, operating profits have been falling from about $7 billion just after the merger, to $5 billion and change here, as debt reduction has been painfully slow.
For the year 2022, the company posted a flattish sales number around $26 billion, while EBITDA fell by 4% to $6.4 billion. With adjusted earnings posted shy of $3 per share, adjusted earnings multiples looked reasonable. Net debt of $18.4 billion translated into a 3 times leverage ratio based on EBITDA.
Through the summer of 2023, shares traded in the mid-thirties. This came after first quarter sales rose by more than 7%, which looked better than they were, with pricing up an astonishing 15%, offset by 5% declines in volumes, and the remainder being the impact of divestments.
Second quarter sales growth slowed down to just 2% and change, as price growth came down to 11%, with volume/mix down as much as 7%. While the composition of sales was poor, adjusted earnings improved quite a bit on a sequential basis. Even as earnings might come in around $3 per share for 2023, and leverage was stable at $19 billion, valuations looked reasonable.
However, the composition of the sales growth was quite worrying, as the company relied for all (and some more) on pricing, with volumes down quite a bit. Frankly, the great benefit is that of a 4.5% dividend yield, as that yield should be rather safe, although less competitive in a high interest rate environment at the time.
Trading Dead Flat
Since the summer of last year, shares of Kraft Heinz have been trading dead flat on a net basis. Currently trading at around $35 per share, shares have traded in a $31-$39 trading range over the past year.
Following a weaker third and fourth quarter, in part due to the fact that 2023 had one working week less, reported sales for 2023 rose by 0.6% to $26.6 billion. The composition of growth remained poor, with full-year pricing up 890 basis points, offset by a 550 basis point decline from volume/mix and divestments.
With the business relying so much on pricing, profitability improved a bit. Adjusted EBITDA was up 5% to $6.3 billion, with adjusted earnings up 7%, or twenty cents, to $2.98 per share. Net debt was pretty stable at $18.6 billion, with deleveraging attempts held back by the continued payouts of the quarterly dividend of $0.40 per share.
Amidst inflation coming down, the company guided for organic revenue growth between flat and up 2% for 2024. Price was expected to be a key driver in this, with volumes expected to turn positive in the second half of the year. With very modest sales growth seen, the company saw adjusted earnings up modestly to $3.01-$3.07 per share.
The company started the year on a soft note, with reported sales down 1.2% as a 270 basis point contribution from price was more than offset by a 320 basis point headwind from volume/mix. Nonetheless, the company managed to squeeze out a penny increase in adjusted earnings.
Second quarter sales softened, with reported sales down 3.6% as a mere 1% increase in pricing was still accompanied by a 340 basis point decline in volume/mix. Nonetheless, the earnings decline was limited to a penny.
Net debt ticked up to $19.0 billion, as the company actually embarked on half a billion share buybacks so far this year. Following the softer quarter, the company sees full-year organic sales anywhere between flat at best and minus 2% at the worst. The company maintained the earnings per share guidance, larger due to modest share buybacks engaged upon.
Totally Stuck
The reality is that it feels as if the business and shares are trending absolute dead flat. Sales, profits, earnings per share, and leverage are all quite constant compared to last year. At the same time, the composition of the sales keeps deteriorating (with volumes down and prices up), as frankly the only thing going for the shares is the current 4.5% dividend yield.
It is hard to see the inflection point here needed to ignite growth and potential, as a 12 times adjusted earnings multiple is very modest, but it is low for a good reason.
The elephant in the room is, of course, Berkshire (among others) holding just over a quarter of the shares here. While there is always speculation, whether it would increase or decrease its stake, the reality is that not much has happened with regard to its ownership position. Hence, the sad reality is that there are very few green shoots and triggers for the shares here.
Increased consumer focus on processed foods continues to create a drag, as consumers have been strapped for cash in an inflationary environment. This hurts the business with its focus on premium brands (and associated pricing).
While this was more than compensated by pricing last year, that is no longer the case, as inflation in the food isle now trails general inflation, and volume declines persist (even after easy comparable versus this point last year).
This makes it very hard to be very upbeat, and sadly leaves me sitting on a long term break-even position, on which I have enjoyed very little returns, other than a solid dividend yield here.
