Shares of Kraft Heinz (KHC, Financial) have proved a disappointing investment of late. Over the past three years, the stock has delivered a total return of roughly 8.3%. Comparably, the S&P 500 has delivered a total return of roughly 38% over the same time period.
Kraft Heinz shares have struggled for a variety of reasons including multiple contraction, concerns related to the impact of GLP-1 weight loss drugs, and weak performance of the business. Despite these challenges, investing guru Warren Buffett (Trades, Portfolio) continues to hold Kraft Heinz shares and is the company's largest investor.
I believe the stock represents an attractive value opportunity at current levels as it trades at a significant discount to peers while having similar growth prospects.
Company Overview
Kraft Heinz is a leading food in beverage company with global operations. The company was formed through a 2015 merger of Kraft Foods and H.J. Heinz Corporation. Key brands owned by the company include Kraft, Oscar Mayer, Heinz, Lunchables, Ore-Ida, Jell-O, Kool Aid, Maxwell House, and others.
The company derives roughly 70% of its revenue in the U.S. with key international markets including Canada and the U.K. Condiment and sauces are the largest product category for the company accounting for roughly 33% of revenue. Kraft Heinz's largest customer is Walmart which accounts for roughly 21% of the company's global sales.
Key competitors include other food companies such as Conagra (CAG, Financial), General Mills (GIS, Financial), and others. The company also faces competition from private label products offered by food retailers such as Walmart and Kroger. While the food business is highly competitive, the company has been able to deliver consistent profitability.
Warren Buffet is the company's largest shareholder
Warren Buffett (Trades, Portfolio)' Berkshire Hathaway became a Kraft Heinz shareholder via its initial investment in H.J. Heinz. In 2013, Berkshire partnered with Brazilian private equity firm 3G Capital to take H.J. Heinz private. In 2015, H.J. Heinz merged with Kraft Foods to create Kraft Heinz. As part of the transaction, Berkshire acquired additional shares in Kraft Heinz as part of a $10 billion additional equity commitment in partnership with 3G Capital.
Following the announcement of the deal, Kraft Heinz shares traded as high as the mid 80s amid optimism over the transaction. However, the stock has moved significantly lower from those levels and thus the investment has been disappointing for Buffett thus far.
Buffett has said that he was wrong on Kraft Heinz in that he overpaid but noted that he believes that the company has a collection of strong brands which he would be happy to own over the long-term. 3G Capital, Buffett's initial partner in the transaction, exited its investment in Kraft Heinz in 2023 but Buffett continues to hold.
As of the most recently available filing information, Berkshire owns roughly 326 million shares of the company or roughly 28% of shares outstanding. The investment is Berkshire's 7th largest public equity investment. It is notable that Buffett has not reduced his Kraft Heinz investment despite significantly reducing the size of Berkshire's public equity portfolio in recent months with large sales of Apple and Bank of America. Berkshire realized significant capital gains on both sales as Berkshire's Apple and Bank of America investments were purchased at much lower levels than current prices. Thus, selling Kraft Heinz would have represented a potentially attractive way to offset those gains with losses since Kraft Heinz shares have declined significantly since Buffett made his additional investment in 2015. For this reason, I view Buffett's decision to continue holding the stock as a significant endorsement of the stock at current levels.
Growth strategy
The past few years have proved challenging for Kraft Heinz as the company has struggled to deliver earnings growth. In response, the company has implemented changes and replaced its CEO in early 2024. The company's strategy is now focused on improving business efficiency by focusing on profitable growth as opposed to growth at any cost. The company has shown some progress as adjusted gross profit margins, on a year-to-date basis, has expanded by 190bps compared to the same period a year ago. Moreover, despite an increased focus on profitability the company has continued to invest in its brands as SG&A expense and CapEx have risen 6% and 7% on a year-to-date basis vs the same period during 2023.
Recent moves to support the company's growth strategy include expanding distribution channels and increasing focus on value. Kraft Heinz CEO Carlos Abrams-Rivera outlined these initiates at an industry conference in early September:
“One of the things we have learned through this year is that as consumers are looking for more focus on value, they're also expanding the number of channels in which they purchase. So it's no accident that we have increased by 13% the number of distribution in our Dollar General stores, that we have increased 10% in club stores, and that we continue to make sure we have the right formats so that consumers who are feeling like the best way to address my cash flow in the family is to go to a club store because I'm going to be thoughtful about the price point per ounce or per serving that we have a product for them.
And that's why we take a product, Capri Sun, that's always been in the pouch and actually bring it to a bottle that is 32-ounce and is a lower price per serving. But it's also making sure we have a dollar product in many of our Oscar Mayer businesses that are being present now in Dollar General in a way for us to make sure that we have an entry price point for families that really are managing kind of a weekly cash flow.
Emerging markets also represent a key growth area for the company as roughly 10% of the company's total sales come from emerging markets with a focus on Brazil, China, Indonesia, and Mexico. I believe this segment represents an important growth driver for the company as emerging markets are growing faster than developed markets and the company been growing share of late. Moreover, emerging markets were a particularly bright spot in the most recent quarter with the company delivering organic net sales growth of 3.4% on a year-over-year basis.
Currently, consensus estimates call for Kraft Heinz to report earnings per share growth of 4.5% in FY 2025 and 5.5% in FY 2026. While this level of growth is well below the broader market, it is inline with other food and beverage companies such as General Mills, Conagra, and Mondelez (MDLZ, Financial) For FY 2024, the company currently forecasts adjusted EPS of $3.01 - $3.07 which represents 1%-3% growth on a year-over-year basis.
Valuation is attractive
Currently, Kraft Heinz shares trade at just 11.4x consensus FY 2024 earnings and 10.9x consensus FY 2025 earnings. Comparably, the S&P 500 trades at roughly 23.5x consensus forward earnings. Thus, on a relative basis Kraft Heinz is trading at a much cheaper valuation. However, Kraft Heinz has less earnings growth potential than the broader market which argues for a valuation discount. On the other hand, as a food and beverage company Kraft Heinz earnings have less cyclicality than the broader market which argues for a valuation premium. Given these offsetting factors I believe peer valuation comparisons are more useful than comparing Kraft Heinz's valuation to the broader market.
Kraft Heinz's closest peer companies include Conagra Brands, General Mills, Kellanova (K, Financial), and Mondelez (MDLZ, Financial) which trade at 11.4x, 15.6x, 20.6x, and 20x consensus FY 2025 earnings per share. This group trades at an average of 16.9x consensus FY 2025 earnings per share which represents a roughly 48% premium to the forward multiple Kraft Heinz currently trades at. Consensus estimates call for each of these companies to report mid-single digit earnings growth over the next few which is inline with consensus earnings growth estimates for Kraft Heinz. One thing that should be noted is the Kellanova has recently agreed to be acquired by Mars and thus the current valuation represents a comparable transaction valuation. Transaction based multiples tend to result in among the highest valuation multiples for companies as the buyer is paying a control premium. That said, I believe the transaction is important in that it signals the relatively high valuation multiple that sophisticated parties are willing to pay for slow growth foods.
Kraft Heinz also offers a dividend yield of 4.5% which is near the high end of its peer group. Comparably, Conagra, General Mills, Kellanova, and Mondelez offer dividend yields of 4.7%, 3.3%, 2.8%, and 2.6%. In addition to trading at an attractive valuation multiple vs peers, Kraft Heinz is also trading at an attractive valuation relative to its own historical norm. The stock has traded at a median price to earnings ratio of 24x over the past decade and has traded at a median dividend yield of 4.28% over the past decade.
Additionally, the company initiated a $3 billion repurchase program in November 2023 and has been an active purchaser of late having repurchased 6 million shares during the three months ending June 30, 2024. I believe that repurchase activity suggests that management views the stock as attractively valued at current levels.
Leverage and inflation are key risks
One key risk to the bull case for Kraft Heinz is the company's highly levered balance sheet. Currently, the company has a net leverage ratio of 3.1x which is roughly inline with the company's leverage target of 3x. The company's high degree of leverage means that it has relatively little room to handle any significant business challenges. Moreover, the company's high degree of leverage could become problematic if interest rates move significantly higher from current levels as the company would likely face a significantly higher interest burden. That said, the company's debt is well laddered with most debt not coming due until after 2028.
A potential return to higher levels of inflation also represents a key risk to the company as rising input prices have the potential to result in margin pressures. Moreover, rising food prices make it more difficult for consumers to pay up for brand name products that Kraft Heinz offers. Comparably, private label products tend to be significantly cheaper and thus become more attractive to consumers when prices rapidly increase.
Conclusion
Kraft Heinz has proven a disappointing investment of late but is now trading at a highly attractive valuation. Despite recent challenges, Warren Buffett (Trades, Portfolio) has not lost confidence in the company and Berkshire remains Kraft Heinz's largest shareholder. Moreover, I believe the fact that Buffett has decided not to sell Kraft Heinz shares despite the potential to use losses to offset gains on recent sales of Apple and Bank of America serves as an indication of his conviction in the position. As arguably the greatest value investor who has ever lived, Buffett's endorsement is a key positive. I believe this is especially true for a deep value-oriented stock such as Kraft Heinz.
The company has struggled to grow earnings in recent years but has embraced a plan focused on driving profitable growth. I believe new distribution channels in the U.S. as well as a continued focus on emerging markets opportunities will allow the company to deliver earnings growth going forward despite operating in a mature industry.
Currently, Kraft Heinz trades at a significant discount to a group of peer companies which have similar growth prospects as well as a significant discount to its own historical norm valuation. The company has also been repurchasing its own shares suggesting management views the stock as attractively valued at current levels. For these reasons, I believe the stock is undervalued at current levels and represents a compelling value investment opportunity.
