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Bears vs. Bulls: Who’s Right About Kraft Heinz Stock?

Kraft Heinz's (NASDAQ: KHC) stock plummeted more than 60% over the past two years as it struggled with decelerating revenue growth, contracting margins, big writedowns for its top brands, a dividend cut, and an SEC probe regarding its accounting issues, as well as delayed earnings reports and SEC filings.

Last July, Kraft hired former AB InBev executive Miguel Patricio as its new CEO to lead a turnaround effort. Yet progress has been glacial, and even 3G Capital -- Kraft's second largest shareholder -- subsequently sold 25 million shares and reduced its overall stake to about 20% by late September.

It's tempting to buy Kraft after that precipitous plunge, since the stock trades at just 11 times forward earnings and pays a forward yield of 5.3%. However, the company's recent fourth-quarter report indicates that it's still struggling to fix its business.

Image source: Getty Images.

What the bears will say about Kraft Heinz

The bearish case against Kraft Heinz is straightforward: Sales of its packaged foods will continue fading as it faces tougher competition from healthier foods and private-label brands. Its focus on cutting costs instead of innovating or acquiring higher-growth brands is also making it tough to generate fresh growth.

Under former CEO Bernardo Hees, Kraft desperately tried to boost its organic sales by slashing prices -- which backfired and reduced its margins. As a result, Kraft Heinz's organic sales have declined annually over the past four quarters, and its adjusted EBITDA margins are still declining.

Metric

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Organic sales (YOY)

2.4%

(2.8%)

(0.3%)

(1.1%)

(2.2%)

Adjusted EBITDA margin

24.7%

24%

25%

24.2%

23.9%

YOY = Year-over-year. Source: Kraft Heinz quarterly reports.

Kraft's 2.2% decline in organic sales in the fourth quarter broadly missed the consensus forecast for a 0.9% decline. Its organic sales fell across all of its global regions except the EMEA (Europe, Middle East, and Africa) region, which eked out 0.3% growth.

Image source: Getty Images.

Patricio doesn't have much room to expand Kraft Heinz's business via acquisitions, since it's currently shouldering $28.2 billion in long-term debt. Kraft tried to divest some of its weaker brands last year, but ultimately failed to find any buyers.

That's why Patricio is relying on a "zero-based budgeting" strategy, which cuts costs across the company's existing businesses to free up cash for new R&D and marketing strategies. Patricio is also reversing Hees' damaging discounts and boosting its prices again to offset its weaker shipments. Unfortunately, neither strategy lifted its organic sales or adjusted EBITDA margin during the fourth quarter.

Kraft didn't provide exact revenue guidance for 2020, which leaves investors in the dark regarding its turnaround efforts. But during the conference call it warned that its full-year adjusted EBITDA would decline nearly 8%, due to divestments, supply chain cost and commodity inflation, aggressive competition, and currency headwinds.

What the bulls will say about Kraft Heinz

The bulls will likely acknowledge these challenges, but also note that the stock's low valuation and high yield should set a floor under it.

They'll also note that the company expects to generate "at least" $500 million more in free cash flow than its dividend payments warrant in 2020, and that CFO Paulo Basilio called maintaining that payout a top "priority" during the conference call. This indicates that Kraft probably won't cut its dividend again in the near future.

The bulls will point out that hiking prices to offset slower shipments worked for General Mills and PepsiCo, which both face similar challenges as Kraft Heinz. Both companies are now generating positive organic sales growth again in a tough market.

Kraft Heinz's top investor, Warren Buffett's Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B), also hasn't sold any shares after engineering Kraft's initial merger with Heinz. This suggests that Berkshire is willing to give Patricio's team a chance to revive its iconic brands -- even if the near-term prospects look grim.

So are the bears or bulls right about Kraft Heinz?

Kraft's downside might be limited at these levels, but I don't think it's a compelling buy yet. The headwinds will remain fierce throughout most of 2020 as it struggles with declining sales and contracting margins. It's also arguably smarter to simply buy General Mills or PepsiCo instead of waiting for Kraft to recover.

So for now, the bears still have a clear advantage -- but the bulls might eventually prevail if the new management team breathes fresh life into the company's aging brands.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Anheuser-Busch InBev NV and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short March 2020 $225 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.


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