Misstated Financial Results
Kraft Heinz (KHC - Free Report) is restating its financial results for the past 3 years, following an SEC investigation. Kraft Heinz representative said, “the findings from the investigation did not identify any misconduct by any member of the senior management team.” Their procurement department has been under investigation for the past 3 months to determine if accounting procedures used in this segment were in line with SEC guidelines.
The company restated 2016, 2017 and 2018 EPS with an estimated misstatement being (0.3)%, (1.7)%, and (0.8)% respectively. These restated financials give investors a little more confidence in the stock because they can now quantify the impact. KHC is up about 0.6% in trading today while the broader markets are experiencing a decline on renewed trade concerns
Over the past 3 months, KHC has been through the wringer losing 30% of its value after its most recent earnings release in February. The company reported a massive loss in Q4 which was primarily driven by significant write-downs on major assets including the brands themselves, like Kraft and Oscar Mayer. KHC also substantially cut their dividends which is a sign of concern for any public company, leading investors to conclude the company will not be able to generate enough profits to payout to investors sustainably.
There was also a lot of concern around the investigation into Kraft Heinz’s bookkeeping, leaving investors unsure of potential legal liabilities that the company could accrue. These misstated financial results illustrate a lack of internal controls in the firm. The preliminary financial restatement released today was a solid step in the right direction and putting investors’ minds at ease slightly.
The Merger and The PE Mentality
Kraft Heinz was created through a merger in March of 2015 between Kraft Foods and H.J. Heinz which was owned by 3G Capital, a Brazilian private equity fund, and Berkshire Hathaway (BRK.B - Free Report) , Warren Buffett’s investment holding company. This newly created firm, Kraft Heinz, became the 5th largest consumer packaged goods company in the world by revenue. The assumption was that the combination of these two CPG powerhouses would help them achieve larger economies to scale and leverage distribution and facility synergies.
Kraft Heinz selected Bernardo Hees, a partner at 3G Capital, to be this new firm's leader and CEO in 2015. Bernardo Hees thinks like any private equity investor, making efficiencies within the company in order to cut costs and drive the bottom-line for short-run profits to boost the stock until they divest their position. 3G Capital’s average holding period for any position is 3-5 years which is typical for a PE firm. This burn & churn mentality is how PE firms are able to achieve strong returns for their investors. Unfortunately for 3G Capital they didn’t divest quickly enough from this venture to be profitable and are now attempting to pivot their strategy to salvage the investment.
Bernardo Hees stepped down at the end of April for obvious performance reasons and is being replaced by Miguel Patricio who was the Chief Marketing Officer (CMO) at Anheuser-Busch InBev between 2012 and 2016. This is a move made by 3G Capital who has a 27% stake in Anheuser-Busch. An analyst at Credit Suisse, Robert Moskow, saw this as a positive shift saying, “we think this change at the helm is a good sign for investors because it demonstrates that the company is very serious about pivoting its priorities toward growth rather than just cost-cutting.”
It is unfortunate to see a company like Kraft Heinz get run into the ground, overheating cost-cutting and expanding margins to a fault. This private equity mentality is what caused KHC to lose over 60% of its value over the last 2 years.
Fundamentals Point to an Oversold KHC
KHC is trading at an 11.43x forward P/E far below the industries average of 17.1x and down more than 50% from KHC’s 25x forward P/E in Q1 2017. KHC is sitting at a price to cash-flow of 3.43x nearly ¼ the CPG industries 12.48x. I believe that the new CEO Miguel Patricio, who has experience expanding a fortune 500 firm’s market, will have a positive impact on this dying CPG firm.
Consumer Packaged Goods (CPG) firms are a declining category in the world today. Millennials are now the largest consuming generation (ages 23-38) and they have a renewed focus on “healthy living” which doesn’t include over processed CPG products. I do not have a good feeling about Kraft Heinz in the long-run, but I believe that the company is currently oversold and traders could see a nice return once Kraft Heinz regains its bearings.
If management is willing to sacrifice short-term margins to invest in its brands for future sustainable growth than this company may still have a fighting chance to gain market-share and expand operations. KHC – Zacks Rank #3 (Hold)
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