As a conservative-minded, value and fundamental-driven investor, my natural tendency is to shy away from stocks that market experts and popular market media analysts tend to talk to the most about. That means that my investments generally don’t look very sexy – but I’m far less interested in being sexy than I am in being able to keep my money working for me in any market condition. That’s one of the biggest reasons that throughout the course of the last few years I’ve found the Consumer Staples sector, and specifically the Food Products industry a good place to find useful investing opportunities.
In 2018 and 2019, a lot of that opportunity was being driven by international trade concerns that increased uncertainty in the marketplace. 2020 reaffirmed the industry as a good place to be as the pandemic prompted a massive, albeit unexpected consumer shift back towards value-based packaged foods. Social distancing requirements and dine-in restrictions around the country put a massive amount of pressure on restaurants, bars, and clubs that we normally associate with enjoyable social activities that is still under some pressure, even if many of these activities have resumed in a modified fashion. The latest jobs numbers show that unemployment remains well above the levels seen prior to the pandemic, and in fact unemployment claims have increased over the last several weeks, which means that a large number of American families remain financially pressured. I think that means that food storage and home dining is likely to continue to see healthy demand even as dining out options become more available.
Economic and industry analysts all predicted that the consumer trends I just described will show “stickiness” in 2021,, but begin to fade as economic recovery continues. The extended effect of unemployment concerns however, combined with a pandemic that just refuses to go away are elements, however that I think will continue to be a tailwind for the Food Products industry. There are risks and headwinds, to be sure, including supply chain pressures that are another, persistent side effect of the pandemic. Even so, a lot of the companies in this industry have shown improving fundamental profiles throughout the last year, including material improvements in cash flows, debt reduction, and overall balance sheet strength. Contrast those positives to the current downward pressure on the industry, and I think that means that Consumer Staples will still have its place as a smart place to keep in mind in 2021.
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 even with strong relative price performance since March 2020, a number of Food Products stocks continue to reflect very attractive valuation levels.
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 as well. 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 is 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 the pandemic prompted a stock-your-pantry mindset that gave a lot of companies in this industry, including KHC an opportunity to recapture lost customer and gain new ones. The question that remains, however is whether those positives have translated as expected to the company’s bottom line? 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 $45.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by -2.5%, while sales dropped by -0.5%. In the last quarter, earnings grew by 8.33% while sales increased by about -3.5%. KHC’s margin profile is a warning sign; Net Income as a percentage of Revenues was 8.2% over the last twelve months, but weakened markedly in the last quarter, to -0.41%.
Free Cash Flow: KHC’s free cash flow was a little over $3.9 billion (a sizable improvement from $560 million in mid-2019) over the past twelve months and translates to a useful Free Cash Flow Yield of 8.76%. It is worth noting that this number declined from almost $6.2 billion in the last quarter of 2020 and $4.8 billion in the quarter prior. That more recent, downward sloping trend in Free Cash Flow is a confirmation of the weakness in Net Income the last quarter just revealed.
Dividend Yield: KHC’s dividend is $1.60 per share, and translate to an above-average yield of 4.31% at its current price.
Debt to Equity: KHC has a debt/equity ratio of .47. This is a low number that I think is a bit misleading given a high proportional level of debt versus cash and liquid assets. Their balance sheet shows $3.9 billion in cash and liquid assets against more than $23 billion in long-term debt. While debt is below the $31 billion mark it saw in mid-2020, cash has also declined from about $5.4 billion at the beginning of 2020. It is also worth noting that cash and liquid assets increased from $2.36 billion in the quarter prior.
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 $53 per share. That means the stock is trading at a big discount, with about 43% upside from the stock’s current price. KHC’s fair value target today is a bit below the level this same analysis yielded just a few months ago, at around $58 per share.
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 year. The diagonal red line traces the stock’s upward trend from an October low at around $28.50 to its high point in late May at about $45 per share. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From its May high, the stock dropped into a steady downward trend that appears to have found bottom in September at the 61.8% retracement line, sitting around $35. The stock has built some gradual, bullish momentum from that point and is currently sitting a little above the 50% retracement line, marking current support at around $37 per share, with immediate resistance sitting at around $39 where the 38.2% retracement line waits. A drop below $37 should find next support at the 61.8% retracement line, giving the stock about $2 of downside if support fails, with about $2 of upside right now to immediate support from the stock’s current price.
Near-term Keys: KHC’s building, bullish pattern over the last month is an encouraging sign that its current downward trend might be reversing. With the stock sitting right on top of current support, a good bullish signal would come from a bounce off of $37 per share, using $39 as a useful, bullish short-term exit target and room to about $41 a distinct possibility if buying pressure increases. A drop below support at around $37 could offer a signal to consider shorting the stock or buying put options, using $35 per share as a practical initial target. The stock’s value proposition is very compelling, however the company’s fundamentals have shown some signs of deterioration in the last quarter. Those could be cyclical questions that are resolved in the months ahead – but I think they are significant enough to make a selective value hunter look elsewhere for now.