Valuentum Exclusive Analysis for the Discerning Investor

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Image: Years ago, shares of Kraft Heinz registered a rating of 1 on the Valuentum Buying Index (VBI) on two separate occasions, highlighting the company’s overpriced nature and weakening technicals. Rare and extreme ratings on the VBI, 1 = worst; 10 = best, tend to be the most informative and/or the most actionable for investors.   

There are just too many net cash rich, free cash flow generating powerhouses with tremendous competitively advantaged business models tied to secular growth tailwinds that taking a flier on an overleveraged turnaround such as Kraft Heinz almost feels irresponsible. That said, shares yield ~5.2% as of this writing, so income investors might find a decent risk reward at the right price. With a 27% stake, Buffett's Berkshire Hathaway seems to think so.

By Brian Nelson, CFA

Kraft Heinz (KHC) has been somewhat of an embarrassment for Warren Buffett’s Berkshire Hathaway (BRK.B), which is still the company’s largest shareholder at a 27% stake. KHC’s shares had been massively overpriced years ago, and on two separate occasions (September 2016, June 2017), they registered a 1 on the Valuentum Buying Index (VBI), exchanging hands in the high $80s at the time (1 = worst).

After Kraft Heinz’s third-quarter report, released October 29, the company is now trading just north of $30 per share (a far cry from its glory days). The company is one of a number of great examples of the power of the VBI (in this case, in highlighting stocks poised for a collapse). Though Kraft Heinz may not have been the best idea out there for investors years ago, the firm is taking the necessary steps to get back on track, from what we can tell. Aggressive cost cutting, the exiting of several underperforming assets, and the anticipated sale of part of its cheese business should help this staple turn the corner.

The company’s net sales advanced 6% in the third quarter, while gross profit increased more than 20%. Adjusted EBITDA advanced 13.5%, and adjusted earnings per share edged higher during the period. Kraft Heinz has benefited from at-home consumption by consumers cocooning in their residences due to the COVID-19 pandemic. The firm also raised its full-year outlook now calling for organic net sales expansion in the mid-single-digit range and high-single-digit constant currency adjusted EBITDA growth. Here’s what management had to say in the press release:

We are building momentum, and we are confidently optimistic about our near-term performance. We are heading into 2021 with our new operating model fully implemented, our platform strategy coming to life in the marketplace, and our growth investments ramping up. And although there are multiple future scenarios we must plan for and manage against, we are in a strong position to both accelerate and exceed the strategic plan we finalized earlier this year.

Things are looking much better for Kraft Heinz than they did 12-18 months ago, and the executive team looks to be in a good position to keep the momentum going into next year, at the very least. So far in 2020, free cash flow has improved considerably over the comparable nine-month period last year ($2.9 billion versus $1.4 billion). Even though we like what we’re seeing as of late, we can’t look past the firm’s massive net debt position, which stood at $25.7 billion at the end of the third quarter.

Members know how much we dislike huge net debt positions and being debt-averse has worked wonders for idea generation. From our perspective, there are just too many net cash rich, free cash flow generating powerhouses with tremendous competitively advantaged business models tied to secular growth tailwinds that taking a flier on an overleveraged turnaround such as Kraft Heinz almost feels irresponsible. That said, shares yield ~5.2% as of this writing, so income investors might find a decent risk reward at the right price. Buffett seems to think so.

View Kraft Heinz’s stock page >>

Brian Nelson owns shares in SPY, SCHG, DIA, VOT, and QQQ. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.