I wrote about Kraft Heinz Co. (KHC, Financial)nearly two years ago, after the company wrote off over $15 billion in goodwill, cut its dividend and informed investors about a Securities and Exchange Commission investigation into its accounting. The stock tanked 27% in a single day after the company released its 2018 results.
I thought it was a good contrarian move to invest in the company. I opined that the market had overreacted. The reasons I gave were:
- The company has reported a modest increase in net sales from $26.259 billion to $26.085 billion – a minuscule move in the right direction.
- The company's operating cash flow (ignoring non-cash impairments and non-cash tax adjustments from last year) is still $3.86 per share, compared to around $5.37 in 2017. The non-cash impairment, while unfortunate, is driven by accounting assumptions of growth and discount rates and is largely an adjustment of already sunk cost. It is, at best, a belated recognition that the company paid too much to buy the said asset originally, and the market conditions do not warrant that valuation.
Since then, a lot has happened. Warren Buffett (Trades, Portfolio) admitted he had paid too much for the Kraft business. The CEO (a finance guy) was dismissed and a new CEO (with brand-building expertise names Miguel Patricio) was brought in.
In hindsight, it was too early to call a bottom (value investors are often early, a common failing). The bottom came a year later with the Covid-19 crisis. The crisis has been a boon to Kraft-Heinz as consumers stocked up their pantries and many of the company's leading brands benefited.
Looking at the chart, we noted that revenue has now stabilized and operating cash flow is up strongly for 2019 and 2020.
The company has started to invest more in its brands, divest underperforming businesses (it has sold its cheese and nut businesses) and deleverage. Long-term debt is down from $30.7 billion in 2018 to $28.07 billion in 2021.
Kraft Heinz has maintained its dividend, in spite of the bond rating agencies cutting their ratings on the bonds to junk. Evidence is accumulating that the company is putting its house in order. The company's net sales grew by 6.2% for the year and adjusted Ebitda increased 14%. The company expects positive sales momentum for 2021 and has guided toward that.
Valuation
The company generates strong free cash flow, but its net income has been erratic. GuruFocus has developed a valuation methodology to deal with such a situation called Projected FCF. This indicates an intrinsic value of $45.74. I think that is reasonable under the circumstances. The GF Value (a proprietary metric) shows that the company is reasonably valued at this point, but I think that is conservative.
The company is currently paying a dividend of 4.52%, which looks safe and well covered by free cash flow. Warren Buffett (Trades, Portfolio) continues to hold the stock. Additionally, First Eagle Investment has taken a large stake.
Disclosure: The author owns shares of Kraft Heinz and continues to add opportunistically.
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