Over the past couple of weeks, uncertainty has started to creep back into the market, after enthusiasm from the reopening of the economy on a national scale even as COVID-19 remains a concern that will persist into 2021. Unemployment is trending lower, but not as quickly as many economists and “experts” seem to expect, and I think there is some legitimate concern that if infections continue to soar, at least some of the restrictions that brought economic activity to a screeching halt earlier in the year could be imposed all over again, and so force jobless claims to move back higher. In the initial, downward phase of the pandemic and resulting recessionary downturn, I wrote quite a bit about looking for generally more conservative ways to put your money to work for you. One of my personal favorites is the Food Products industry, which I believe can still 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 their historical highs, despite the fact that over the last few months they may have staged surprising turnarounds and bullish rallies of their. 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, and while the pandemic prompted a stock-your-pantry mindset that gave a lot of companies in this industry, including KHC some positive headwinds, the end result of their transformation is 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 $38.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased about -12%, while sales grew 3.32%. In the last quarter, earnings and revenues were both negative, at about -19.4% and -5.8%, respectively. KHC’s margin profile is generally healthy, at 7.58% over the last twelve months, but weakened in the last quarter, at 6.14%. It is worth noting that in 2019, Net Income over both time periods was dramatically negative.
Free Cash Flow: KHC’s free cash flow was about $4.85 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 11.96%.
Dividend Yield: KHC’s dividend is $1.60 per share, and translate to an above-average yield of 5.02% at its current price.
Debt to Equity: KHC has a debt/equity ratio of .62. 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 $5.4 billion in cash and liquid assets against more than $31.5 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 just little under $52 per share. That means the stock is trading at big discount, with about 62% 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 to its low point in March; it also acts as the baseline for the Fibonacci retracement lines shown on the right side of the chart. From a bear market, multiyear low around $19.90, the stock has staged a pretty impressive rally, peaking in June just a little below $34. The stock has retraced a bit from that point, finding recent support in the $31 range. A drop below that point could see the stock drop to about $28 before finding new support, with additional downside to about $25 if the stock’s current upward trend reverses and bearish momentum accelerates. A push above $34, however would re-confirm the current upward trend and should give it room to test next resistance a little above $37 where the 38.2% retracement line sits, and $42.50 offering a useful next target level if bullish sentiment and momentum remain strong.
Near-term Keys: Given the stock’s momentum since March, the probabilities of success right now lie more strongly on the bullish side for KHC. A good bullish signal would come from a push above $34 per share, with upside to $37 as a quick-hit exit target. If the stock drops below $31, you can also consider shorting the stock or working with put options, using $28 as an early bearish profit target. The stock’s value proposition is very compelling, and the fundamentals have been improving for the year, which makes the long-term potential very interesting – and could even be turning into compelling territory. At the very least, KHC is a Food Products stock that is worth keeping in your watchlist.