KHC is down -11% in 2023. Does that make it a good value?

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. 

Another way to describe this mindset uses the word “contrarian,” and it’s a mindset that I think becomes more useful when market uncertainty increases. Being a contrarian with a purposely conservative approach 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” for the next hot stock that everybody else is talking about. 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. 2022 added new elements of uncertainty with high geopolitical uncertainty between Russia and the rest of the West that stands behind Ukraine,  along with inflation and rising interest rates, to highlight the biggest themes that continue to drive economic and market momentum this year. Those are having a direct impact on Food Products, where prices have been rising at grocery stores across the country, putting an even heavier emphasis on value when it comes to stocking your pantry.

Economic and industry analysts all predicted that the consumer trends I just described would show “stickiness” in 2021, but begin to fade into 2022 and 2023. While a number of companies in this industry can continue to boast healthy balance sheets, the fact is the rising input costs as a result of supply pressures and rising interest are also having an effect, raising consumer prices across the board to levels not seen in roughly thirty years. That means that Consumer Staples stocks could still offer good value while continuing to be resilient the longer economic difficulties continue. I think there is an important caveat to keep in mind, which is that it is also increasingly important to be very selective, and conservative about when you take a position as well as which stocks represent the best targets of opportunity.

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 this year’s overall bearish condition means that there a lot Food Products stocks that reflect very attractive valuation levels – but not all of them pass muster when you drill down into the details.

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. While KHC benefited from some of the same stock-your-pantry mindset from the pandemic as its competitors, it continues to work through some of those transformational issues that predate 2020. What does that mean about the stock’s value price? 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 $46.1 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by 7.6%, while sales grew by 10%. In the last quarter, earnings increased by almost 35% while sales were nearly 13.5% higher. Confirming the positive earnings pattern is KHC’s margin profile, which is showing signs of strength; Net Income as a percentage of Revenues was 8.92% over the last twelve months, and strengthened in the last quarter to 12.06%.

Free Cash Flow: KHC’s free cash flow was more than $1.6 billion (marking a sizable improvement from $560 million in mid-2019) over the past twelve months and translates to a modest Free Cash Flow Yield of 3.5%. It is worth noting that this number declined from almost $6.2 billion in the last quarter of 2020, and $4.1 billion a year ago, and $3.5 billion in the most recent quarter. That downward sloping trend in Free Cash Flow, stands in direct contrast against the strength being shown by the pattern already described by the last quarter’s Net Income, and I believe is a residual reflection of rising costs and the current inflationary environment.

Dividend Yield: KHC’s dividend is $1.60 per share, and translate to an above-average yield of 4.19% at its current price.

Debt to Equity: KHC has a debt/equity ratio of .39. 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 just about $1 billion in cash and liquid assets (down from $2.9 billion a year ago) against about $19.2 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 a little above $35 per share. That means the stock is overvalued at its current price, with about -9% downside from the stock’s current price. A more practical discount price is seen at around $29 per share.

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 high at around $45 to its low, reached in late September at about $33 per share. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. After rallying to a January peak around $43 per share, the stock has dropped back into a new, short-term downward trend, but appears to be stabilizing to establish current support at around $37.50 where the 38.2% retracement line sits. Immediate resistance is is at about $39 based on pivot activity seen in that area in October of 2022 as well as in February of this year. A drop below $37.50 could see near-term downside to about $35.50 before finding next support, while a push above $39 should have limited upside with next resistance at around $40.50, and roughly inline with the 61.8% retracement line.

Near-term Keys: KHC may be consolidating after dropping back from that early January peak. That could be setting the stage for a bullish reversal, which means that you could use a bounce of of $37.50 as an aggressive, and possibly speculative signal to consider buying the stock or working with call options, using $39 as a practical bullish profit target and $40 if buying activity picks up. Given the stock’s proximity to current support, you could also use a drop below $37.50 to consider shorting the stock or buying put options, with $35.50 providing a practical target on a bearish trade. Unfortunately, the stock’s value proposition doesn’t provide a useful argument for buying the stock on a long-term basis, and I think declining liquidity and Free Cash Flow are confirming warning signals that validate the idea of sticking KHC in a watchlist and checking back again later.

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