EUR 850.00 For Business Accounts Only

Morningstar | While Uncertainty Remains at Kraft Heinz, Change Could Be Brewing as New Management Takes the Helm

After digesting Kraft Heinz’s fiscal 2018 results following the delayed release of its 10-K filing, we’re lowering our fair value estimate for the no-moat firm to $54 per share from $60 to reflect more pronounced profit headwinds, including higher input costs in the near term and increased brand spending in the longer term. We expect marketing and research and development to expand to more than 5% of sales in the aggregate over our 10-year forecast versus less than 5% the last few years and our prior forecast of 4%. Further, increased input cost inflation, reflecting higher protein costs related to a reduction in the supply of hogs stemming from China's African swine fever outbreak and elevated transportation costs versus past deflationary trends, also stands to eat into the firm’s near-term margin trajectory. As such, we forecast that operating margins will amount to just 20.5% in fiscal 2019 versus our prior forecast of nearly 25% and will hover around 23% longer term, generally in line with fiscal 2018 but below our prior outlook of 25%. Our forecast for nearly 3% annual sales growth, with about half resulting from higher volume and the remainder from increased prices, remains in place. We still view shares as undervalued given the pronounced pullback the last few months.

Further, we're raising our uncertainty rating for Kraft Heinz to high from medium because of the continuing Securities and Exchange Commission investigation into its procurement practices. While management's recent restatements, related to the timing of previously recognized vendor agreements, supplier rebates, incentive payments, and pricing arrangements, suggest the issue isn't pervasive (amounting to just around $200 million in adjustments in aggregate and resulting in a less than 1% change to annual EPS each of the past three years based on its preliminary estimates), we believe this warrants a slightly larger margin of safety. The issue further supports our Poor stewardship rating.

But the tide could be shifting, as CEO Bernardo Hees is poised to step down and 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. Miguel Patricio, who has spent the past two decades at wide-moat AB InBev, as chief marketing officer from 2012 to 2018, will assume the CEO role at Kraft on July 1. Unlike the previous organizational structure, Patricio is not affiliated with 3G, and based on his initial comments, he could instill a larger commitment to reigniting sales investing further behind its brands, with a focus on innovation that aligns with evolving consumer trends and marketing its new fare, in line with our expectation that Kraft’s brand spending will tick up to a mid-single-digit range over our 10-year explicit forecast.