The Kraft Heinz Co.'s (KHC, Financial) business transformation continues as it reported low double-digit growth in the last quarter of 2021, ending the year on a fairly decent note.
Despite the inflationary headwinds the company is experiencing, its business has grown and has also been able to demonstrate expansion at the gross margin level. Inflation is rampant due to commodities, labor, packaging and transportation, so Kraft Heinz may struggle to pass the cost increases on to consumers without reducing volume in the long term. There is a potential tailwind for the company in the form of a fourth wave of the Covid-19 virus, which is gradually gaining momentum. Let's take a closer look at its operations to evaluate its worth as a potential investment.
Growth and cost management
During the pandemic, Kraft Heinz, like its packaged foods peers, benefited from consumers' preference for eating at home, with retail sales accounting for more than three-fourths of total sales. The company is becoming more relevant to consumers as household penetration and repeat purchases have increased since the implementation of its revamped road map.
Management plans to save $2 billion in efficiency costs by 2024. It appears to be doing so to free up funds to reinvest in its product mix rather than boost profits. Even as broad-based inflationary headwinds beset its consumer product peers, Kraft Heinz seems to be weathering the storm well. It is not only looking to remove inefficiencies from the business surgically, but is also raising prices selectively. Kraft Heinz is likely to shed its less profitable brands and businesses to free up resources to invest in higher-return opportunities, similar to its decision to sell the Planters brand in early 2021. There is a good chance the company may increase its brand spending to stave off market share losses, even though this spending will impede margin gains over time due to the intensely competitive environment in which it operates.
Divestments and acquisitions
Kraft Heinz has been in the process of a turnaround since Miguel Patricio took over in July 2019. Cost reduction through removal of underperforming products and a focus on positioning has been the highlight of this plan.
The company has already eliminated around 1,100 stock-keeping units and the number of innovation projects were cut in half in 2021 as compared to 2019. The cancellation of the McCafe licensing agreement was part of this plan, as was the divestment of its nuts business. The Planters portfolio, which consisted of single variety and mixed nuts as well as trail mix, Nut-rition products and the Cheez Balls, Cheez Curls and Corn Nuts brands, was sold to Hormel Foods (HRL, Financial) for $3.35 billion in cash in 2021. The segment contributed $1.1 billion to Kraft’s top line. Management believes the sale will help them refocus on other high-growth categories.
Kraft also acquired Germany-based Just Spices GmbH, a direct-to-consumer business that sells 70% of its ready-made and one-step spice blends directly to consumers. The company has a strong presence in Germany, Spain, Austria and Switzerland.
The company's marketing budgets are also being gradually increased with a focus on specific projects yielding a higher return on investment. If the success of this turnaround plan continues the way it has for the past year, then the company is definitely on the right track.
Online grocery purchasing upside
The continued trend in online shopping is bound to drive Kraft Heinz’s sales in the long run. Given the strong brand power of its portfolio and its ability to build on a digital marketing strategy, the company’s online sales should continue to grow. From a macro perspective, online grocery sales, which were originally estimated to account for 4.3% of all grocery purchases in 2020, actually made up over 10% of the total for the year. Their share is expected to be as high as 20% by 2025. The biggest beneficiaries of this trend are expected to be companies with big brands and good spending power like Kraft Heinz.
Kraft has also been able to demonstrate its ability to boost sales through price increases without letting the unit volumes drop, though it is uncertain as to how long it can continue to do so. If it is able to maintain a favorable price volume mix, Kraft Heinz is expected to continue having good results.
Final thoughts
Kraft Heinz is a classic defensive play and I see limited volatility in the stock despite inflationary pressures, rising interest rates and geopolitical tensions. The company is valued at an enterprise value-to-revenue multiple of 2.47 and a price-earnings ratio of 45.88, which are a tad bit on the higher side when compared to averages for the consumer packaged goods industry.
The company is facing its fair share of challenges, such as the increasing consumption of fresh foods and the gradual erosion of the market for processed foods. It is also seeing stiff competition from many smaller players, particularly retailers' private labels. Overall, despite an interesting turnaround story, Kraft Heinz is a relatively expensive bet given the challenges ahead.
