Morningstar | Sales and Profits Continue to Languish at Kraft Heinz, Evidencing Its Lack of a Competitive Edge
For nearly three years, Kraft Heinz's strategic bent has centered on driving out inefficiencies from the organization (by reducing its workforce, rationalizing its North American manufacturing network, and enhancing its supply chain). And the tangible gains that have resulted from these efforts are undeniable. More specifically, the firm now boasts operating margins in the mid-20s, a level that towers above the mid- to high-teens generated by its packaged-food peers.However, sales have languished, falling 1% on an organic basis on average since fiscal 2015. We think the missing piece of the puzzle has been effective brand spending, which has amounted to just 2%-3% of sales annually at Kraft Heinz versus mid- to high-single-digit levels at peers. Management has articulated a desire to up the ante on its brand investments to hone its organic operations, but we've yet to see evidence that it is willing to sacrifice profitability to any material extent over a longer horizon to do so. And as a result of its tepid spending levels, the firm's retail relationships have also shown some cracks. For one, Kraft Heinz is still reeling from lost distribution of Planters (one of its eight brands that generates more than $1 billion in annual sales) through the domestic club channel earlier in 2017, which contributed to a nearly 2% volume shortfall in the fourth quarter in the U.S.Kraft Heinz previously alluded to the fact that further opportunities for efficiency gains were still in the cards, in line with our thinking it would be poised to take out more than its targeted $1.7 billion in costs. However, we view this as an opportunity to free up funds to invest behind its brands and offset more elevated levels of inflation, rather than merely bolster its margins. In this context, higher raw material costs, combined with elevated transportation and logistics costs (which are hampering profitability for companies across the domestic consumer product landscape), continue to take a toll and show little signs of abating. Further, our forecast calls for 4% of sales to be allocated to research, development, and marketing annually, essentially keeping operating margins in the mid-20s.Kraft Heinz is a food and beverage company. The company manufactures and markets food and beverage products, including condiments and sauces, cheese and dairy, meals, meats, refreshment beverages, coffee, and other grocery products throughout the world. The company has three reportable segments defined by geographic region: United States, Canada, and Europe, Middle East, and Africa. The company's remaining businesses are combined and disclosed as Rest of World. Rest of World comprises two operating segments: Latin America and Asia Pacific.
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