This week, the market continues to be volatile, but uncertain. Coronavirus, Super Tuesday, geopolitics, trade, interest rate policy – it seems like everything is getting added to the mix right now. Increasing uncertainty is a good reason to start looking for generally more conservative ways to put your money to work for you. That means that defensive-oriented companies like Food companies, which I’ve written about quite a bit in the past and come back to periodically, can be a good place to put your money to work for you right now.
You still have to be careful, though; it’s pretty easy to gravitate to well-known, established names like GIS, CPB, and KR, to name just a few, but just because a company has a great name and brand, it doesn’t mean the stock is a good opportunity right now. It is still important to pay attention to a company’s underlying business – in fact, I would argue that it may be more important than ever, because so many stocks still remain significantly below the highs they’ve found over the last year. That fact can lead to the mistaken notion that it is a bargain; but sometimes, a stock drops off of those historical highs because the market is trying to tell you something.
Kraft-Heinz Co. (KHC) is an example of what I mean. Look in your pantry or fridge, and you’ll probably find a lot of their products on your shelves. In terms of recognizability, there aren’t too many food brands that can claim the brand recognition this company has. Heinz condiments including ketchup, mustard, mayonnaise have been a mainstay of my fridge for years, and Kraft brands like Oscar Meyer are regulars, too. That should mean the company has a stable, strong business, right? Not so fast. One of the big struggles a lot of traditional names in the Food Products business have been fighting has been the trend away from pre-packaged products and into healthier, organic options. While some, like CPB and GIS, seem to finding ways to stay relevant, KHC has struggled. They’re in the midst of a multiyear, long-term transformation strategy, with the end result still not entirely clear.
The valuation numbers for KHC right now, compared to their historical averages, point to an outsized bargain opportunity; but it may also be a classic example of a value trap. The fundamentals have been improving, and the stock’s dividend is among the highest available; but there are still a few holes to consider. Let’s dive in to the numbers so you can decide if this is a company that is worth putting to work for you.
Fundamental and Value Profile
The Kraft Heinz Company is a food and beverage company. The Company is engaged in the manufacturing and marketing of food and beverage products, including condiments and sauces, cheese and dairy, meals, meats, refreshment beverages, coffee and other grocery products. The Company’s segments include the United States, Canada and Europe. The Company’s remaining businesses are combined as Rest of World. The Rest of World consists of Latin America and Asia, Middle East and Africa (AMEA). The Company provides products for various occasions whether at home, in restaurants or on the go. The Company’s brands include Heinz, Kraft, Oscar Mayer, Philadelphia, Planters, Velveeta, Lunchables, Maxwell House, Capri Sun, and Ore-Ida. The Company’s products are sold through its own sales organizations and through independent brokers, agents and distributors to chain, wholesale, cooperative and independent grocery accounts, convenience stores, drug stores, value stores, bakeries and pharmacies. KHC’s market cap is about $31.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased almost -15%, while sales dropped about -5%. In the last quarter, both earnings and revenues were positive, at a little more than 4.35% and 7.57%, respectively. Despite that improvement, the company’s margin profile turned sharply lower in the last quarter versus the trailing twelve months. Over the year, the number is 7.74%, narrowing to 2.78% in the last quarter. It is worth noting that a year, ago, both of these metrics were dramatically negative.
Free Cash Flow: KHC’s free cash flow was about $4.66 billion (a sizable improvement from $560 million a year ago) over the past twelve months and translates to a useful Free Cash Flow Yield of just 14.63%.
Dividend Yield: KHC’s dividend is $1.60 per share, and translate to an above-average yield of 6.27% at its current price.
Debt to Equity: KHC has a debt/equity ratio of .55. This is a low number that I think is misleading, because the fact is that the company has an outsized level of debt and liquidity is a question. Their balance sheet shows $2.28 billion in cash and liquid assets against more than $28.2 billion in long-term debt. Both of these measurements have improved in the last year, but continued progress is needed to validate the company’s increasing strength.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at about $48 per share. That means the stock is trading at big discount, with about 88% upside from the stock’s current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: This chart traces the stock’s movement over the last two years. The diagonal red line traces the stock’s downward trend; it also acts as the baseline for the Fibonacci retracement lines shown on the right side of the chart. Over the last year, the stock has followed a mostly sideways downward trend, with $34 acting as top-end resistance and $24 as support. More recently, the stock rebounded off that low support, with near-term resistance in the $28 to $29 range. A break above that level offers some interesting short-term upside to about $34, but the stock would need to break above that level to mark a new, legitimate upward trend. Until then, the stock is more likely to keep hovering in this narrow range. Given the length of the sideways trend, $24 is clearly acting as a strong, emotional level of support; but if the stock drops below that level, it could keep dropping much, much lower.
Near-term Keys: A bullish trade on KHC right now is very aggressive, and possibly even speculative. A good bullish signal would come from a push above $29 per share, with upside to $34 as an exit target. If the stock drops below $24, you can also consider shorting the stock or working with put options. The stock has never been below that level, so forecasting an exit target is difficult; but if you use the $5 between current support and immediate resistance, you can use $19 as potential exit signal point. The stock’s value proposition is very compelling, and the fundamentals have been improving for the year, which makes the long-term potential is interesting, but I’m not quite sure it’s compelling just yet. MY preference would be to wait for another quarter or two to see if the stock’s balance sheet and Net Income continue to improve before taking KHC more seriously.