Should We Buy Kraft Heinz at the Current Price?

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Kraft Heinz (NASDAQ: KHC) stock is down 30% in the past month.  The company is available at an attractive forward P/E ratio of 11.03. Let us analyze the factors that led to the sell-off.

The company released its fourth-quarter 2018 and full year results on February 21, 2019. Revenue for the 4Q 2018 increased 0.7% year-on-year to $6.9 billion and full year, it was flat at $26.3 billion. 4Q adjusted earnings per share came at $0.84 compared to $0.90 for the same period last year.

4Q revenue missed analyst’s estimates by $50 million and EPS missed estimates by 10 cents.  There are various red flags which got investors worried. The company had reported a goodwill impairment losses of $7.1 billion and intangible asset impairment losses of $8.3 billion in the fourth quarter.  On account of these one-time charges, net income came at -$12.6 billion when compared to a profit of $8.0 billion for the same period last year.

The company disclosed a SEC investigation into its accounting policies. It also decided to trim its dividend by 36 percent to 40 cents per share each quarter in order to strengthen its balance sheet.

Deutsche Bank analyst Rob Dickerson cut Kraft to hold from Buy. “However, our visibility with respect to the depth, duration, and general profitability effects of such customer- and consumer-building into 2019 is less clear and lowers our conviction on the name,” analyst Rob Dickerson said in a research note.

NYU Finance Professor Aswath Damodaran feels that the stock is currently fairly valued. “The good news is that, even with a stilted story, Kraft Heinz has a value ($34.88) that is close to the stock price ($34.23). The bad news is that the potential upside looks limited, as you can see in the results of a simulation that I did, allowing expected revenue growth, operating margin and cost of capital to be drawn from distributions, rather than using point estimates.”

Since the merger of Kraft and Heinz in 2015 the companies have done well to reduce costs. However, packaged foods are losing sheen among consumers to fresh foods and lower-priced private label products. The cost-cutting efforts of Berkshire Hathaway and 3G Capital in the case of Kraft Heinz did not go well.

Investors had a great hope on the company due to the strong brands and also the company is backed by Warren Buffet’s Berkshire Hathaway and Brazil’s private equity firm 3G Capital. Investors who had hoped to have good dividend are also left disappointed after the company decided to cut dividends.

The company’s plan going forward is to sustain commercial momentum, more actively manage the portfolio, and strengthen the balance sheet. The company expects growth to improve 2020 onwards. However, investors would be more careful going forward.

Conclusion: The stock is looking attractive after the recent stock sell-off. The company has great brands. However, investors need to remember that the company’s organic growth is slowing and the operating profits will come down due to higher expenses. The company might also avoid acquisitions going forward after the Kraft Heinz debacle.

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