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Kraft Heinz (KHC) benefited from consumers eating at home during the pandemic, with 85% of its sales driven through the retail channel. However, we attribute its more recent performance to its revamped strategy rather than the macro and competitive backdrop. CEO Miguel Patricio has charged the company to pursue lasting efficiencies, increase spending on marketing and product innovation, enhance category management and e-commerce, and leverage its scale to more nimbly respond to changing market conditions. The company targets $2.5 billion in efficiency savings through 2027 and a 30% increase in marketing spending between fiscal 2020 and 2024, which we think stands to support its brand mix and its retail relationships. It also has narrowed its stock-keeping unit count by 20% in North America in the past couple of years. We forecast research, development, and marketing spending to amount to 6% of sales annually on average over the next 10 years, or around $1.9 billion, up from a 4.5% average over the last five years.
Key Morningstar Metrics for Kraft Heinz
- Fair Value Estimate: $53
- Star Rating: 5 Stars
- Economic Moat Rating: None
- Uncertainty Rating: Medium
Economic Moat Rating
We don’t believe that Kraft Heinz’s intangible assets or scale result in an economic moat. Returns on invested capital (including goodwill) have languished, falling short of our 7% weighted average cost of capital in each of the past five years. We attribute this to the prior management team’s decision to prioritize near-term cash flow over protecting the company’s long-term competitive position. The combination of Kraft and Heinz allowed management to extract significant costs from operations, with operating margins that hovered in the low 20s, materially above peers’ mid- to high-teens marks. However, we think this profitability came at the cost of investing meaningful resources behind the company’s brands. Historically, investments in research, development, and marketing amounted to just 4%-5% of sales annually at Kraft Heinz, generally lagging peers. Further, we don’t believe Kraft Heinz enjoys significant pricing power.
Read more about Kraft Heinz’s moat rating.
Fair Value Estimate for Kraft Heinz Stock
Our US$53 fair value estimate implies a fiscal 2024 enterprise value/adjusted EBITDA multiple of around 14 times. Management expects a mid- to high-single-digit increase in input costs this year, on top of two consecutive years of double-digit pressures. While consumers could tighten their purse strings in the face of rising costs, Kraft Heinz’s more muted exposure to private-label products and enhanced agility in aligning its mix with evolving consumer trends should blunt any lasting effect on margins. As such, we forecast gross margin in the low 30s again this year before returning to the mid-30s over the next few years, slightly outpacing historical levels. Longer term, we forecast 2% average annual sales growth and operating margin holding in the low 20s, which aligns with management’s long-term targets for 2%-3% organic sales growth and 6%-8% adjusted EPS growth.
Read more about Kraft Heinz’s fair value estimate.
Risk and Uncertainty
Following changes in its executive ranks in mid-2019, Kraft Heinz has orchestrated significant strategic moves that we think position it to withstand intense competition. Inflation stemming from logistics, labor, raw materials, and packaging has yet to be stifled, but we contend Kraft Heinz is now better suited to combat these pressures. While we don’t see much risk from environmental, social, and governance issues, Kraft Heinz could be forced to recall products if quality standards fall short. In addition, the company could come under increased regulatory oversight if authorities focus on curbing obesity.
Read more about Kraft Heinz’s risk and uncertainty.
Kraft Heinz Bulls Say
- Tempered exposure to private label (11% of sales now versus 17% in 2019) and enhanced agility in responding to consumer trends should blunt any lasting decline in Kraft Heinz’s volume.
- We think Kraft Heinz’s decision to organize the business around six consumer need states affords the opportunity to more effectively tailor its offerings to an evolving market.
- By focusing its manufacturing assets on its highest-turning products and enlisting higher-cost co-manufacturers at the onset of COVID-19, Kraft Heinz appears to have mended its fractured retail relationships.
Kraft Heinz Bears Say
- Inflation has run rampant of late, and it’s possible Kraft Heinz will eventually struggle to pass the hit on to consumers without a more pronounced contraction in volume.
- With supply chain disruptions being rectified and consumers altering spending as pressures on their pocketbooks become more acute, we think competitive intensity could resurface.
- If Kraft Heinz opts to increase its debt load, it could struggle to reinvest in the business while returning cash to shareholders.
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