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 rarely look very sexy – but I’m far more interested in being able to keep my money working for me in any market condition than I am in “chasing the herd.” 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.
Consumer Staples are products and goods that you and I need everyday – food, household goods, and the things that we aren’t going to stop buying even when economic conditions prompt us to reign in personal spending budgets and tighten our belts. In 2018 and 2019, international trade concerns increased uncertainty in the marketplace, which made this industry a smart place to incorporate into a diversified investment portfolio. 2020 reaffirmed the industry’s usefulness 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 the restaurants, bars, and clubs that we normally associate with enjoyable social activities, and even if many of these activities have resumed in a modified fashion, inflationary pressures have been pushing costs higher in these areas to only add an additional layer of complexity to the puzzle, with the Fed even publicly stating its intention to begin raising interest rates at least three times in 2022.
Economic and industry analysts all predicted that the consumer trends I just described would show “stickiness” in 2021, but begin to fade this year and into 2023. Most of those forecasts assumed that economic recovery would continue along a moderate, sustained pace, but the start of the year also showed a much higher-than-expected pace of economic growth that finally prompted the Fed to raise interest for the first time last month, with additional hikes expected as the year continues. Adding even more fire to the prospect of long-term extended costs and, therefore, consumer prices is Russia’s invasion of Ukraine and the global economic sanctions that have been imposed on Russia since then. These are a couple of the primary reasons that I think the improving fundamental profiles a lot of companies in this industry have shown over the course of the past two years are elements that make Food Products stocks a smart place to keep your attention focused.
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 versus the broad market this year, a number of Food Products stocks continue to reflect very attractive valuation levels. Verifying the fundamentals back up those valuations is a critical way to differentiate between good bargains and value traps.
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 this company’s 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, and mayonnaise have been a mainstay of my fridge for years, and Kraft brands like Oscar Meyer are regulars as well. Despite that easy, name-brand recognition, 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 $48.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by -1.25%, while sales dropped by -3.3%. In the last quarter, earnings increased by 21.54% while sales were 6.1% higher. Despite the improving earnings pattern, KHC’s margin profile is a sign of weakness; Net Income as a percentage of Revenues was 3.89% over the last twelve months, and deteriorated in the last quarter to -3.83%.
Free Cash Flow: KHC’s free cash flow was almost $4.6 billion (a sizable improvement from $560 million in mid-2019, and $3.2 billion in the quarter prior) over the past twelve months and translates to a useful Free Cash Flow Yield of 9.12%. The more recent, upward sloping trend in Free Cash Flow is an interesting counterpoint of the weakness being shown by the Net Income pattern.
Dividend Yield: KHC’s dividend is $1.60 per share, and translate to an above-average yield of 4.01% at its current price.
Debt to Equity: KHC has a debt/equity ratio of .43. 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 $3.44 billion in cash and liquid assets (down from $3.9 billion two quarters ago) against almost $21 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.
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 $54 per share, above the $50 this same analysis yielded before the latest earnings report. That means the stock is trading at a big discount, with about 38% 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 displays the stock’s movement over the last year. The diagonal red line traces the stock’s downward trend from a May 2021 high at around $45 to its low in December at about $33 per share. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that low, the stock has picked up bullish momentum, driving to a high in late February at around $41 and marking immediate resistance right around the 61.8% retracement line. After dropping back to about $37.50 by mid-March, the stock has picked up momentum again and is a little below that $41 level. Current support is around $39. A drop below $39 should find next support around the 38.2% retracement line around $37.50, with additional downside to about $36.50 if bearish momentum accelerates. A push above $41 should have short-term upside to about $43.50 before finding secondary resistance.
Near-term Keys: KHC has been picking up bullish momentum for the past month and a half, and could be poised to extend is current upward trend if if can break immediate resistance. If you like working with short-term trades, that could also provide a good signal to think about buying the stock or working with call options, with $43.50 providing a decent near-term profit target on a bullish trade. A drop below $39, on the other hand, could be a signal to consider shorting the stock or buying put options, using $37.50 as a quick-hit, bearish profit target. While the value proposition looks attractive, and the company has some useful fundamental strengths including increasing Free Cash Flow and an attractive dividend, the current, negative Net Income is a concern. I would prefer to see this number turn back to positive territory before seriously considering the stock as a useful, long-term, value-based opportunity.