EUR 850.00 For Business Accounts Only

Morningstar | While a Cloud of Uncertainty Still Hangs Over Kraft Heinz, Shares Remain Undervalued

No-moat Kraft Heinz disclosed in a SEC filing on May 6 that the ongoing investigation into its procurement practices (which has resulted in the delayed filing of its fiscal 2018 10-K and its first-quarter 2019 10-Q) would lead it to restate earnings over the course of the last three years. The identified misstatements relate to the timing of previously recognized vendor agreements, supplier rebates, incentive payments, and pricing arrangements. This builds off its announcement in February during which it reversed previously recorded savings of $25 million in the fourth quarter of 2018. Even with its most recent disclosure, this issue doesn’t appear to be pervasive, amounting to just around $200 million in adjustments in aggregate (resulting in a less than 1% change to annual earnings per share each of the past three years based on its preliminary estimates), relative to its cost base of $12 billion spent annually excluding key commodities. We don’t anticipate any change to our $60 valuation on the update (beyond our previously disclosed expectation to trim a mid-single-digit percentage from our intrinsic value assessment). However, we still view shares as undervalued given the pronounced pullback the last few months.

While this latest announcement fails to strike us as significant in terms of its quantitative impact, it lends further credence to our concerns surrounding Kraft Heinz’s stewardship of shareholder capital, which we rate as poor. In our view, the firm’s languishing returns on invested capital and declining sales trend point to a management team that has been prioritizing near-term cash flows and outsize profitability at the expense of its long-term competitive position (as it has failed to direct sufficient resources to support its intangible assets), spending a mere low-single-digit level of sales on research, development, and marketing versus the mid- to high-single-digits level its peers expend.

But it is possible that change is afoot, as this follows the news two weeks ago that CEO Bernardo Hess would be stepping down from the top spot to return to 3G Capital (which acquired Heinz in 2013, orchestrated the merger between Kraft and Heinz in 2015, and still maintains a significant stake in the combined entity). Hess is to be replaced by Miguel Patricio on July 1, who has spent the past two decades at wide-moat AB InBev, serving as chief marketing officer from 2012 to 2018. In a shift from its past organizational structure, Patricio does not have an affiliation with 3G, and based on his initial rhetoric, we surmise that he could instill a larger commitment to reigniting sales by fueling further investments behind its brands (with a focus on innovation that aligns with evolving consumer trends and marketing its new fare), in line with our expectation for Kraft’s brand spend to tick up to a mid-single-digit range over our 10-year explicit forecast.