INTRO: We all know Kraft-Heinz as the legacy food
brand in supermarkets.
From their various condiments to their cheese and ready made meals, Kraft-Heinz is one of
the biggest names in food.
Yet, despite their dominant status amongst the grocery aisles, Kraft-Heinz isn’t actually
doing that well.
Their last few quarters have been hit or miss in terms of profit, they were recently exposed
for an accounting scandal, and their stock is down over 50% from their 2017 highs.
You would think that the top investors would stay miles away from this company, but ironically,
one of the biggest investors in Kraft-Heinz is Warren Buffett.
As you would guess, Kraft-Heinz has been one of Buffett's worst investments of all time.
Buffett has admitted that he did overpay for the Kraft portion of the business, but he
has no plans of selling.
It should be noted though that Buffett owns 26% of Kraft-Heinz, so he really has no easy
way out in terms of selling that large of a stake.
So, his decision to hold may have more to do with a lack of liquidity than an optimistic
outlook for Kraft-Heinz.
This brings up the question, what even happened to Kraft-Heinz and can they actually recover
like Buffett is hoping?
THE COMING OF KRAFT-HEINZ: Taking a look back at the history of Kraft-Heinz,
the company’s story actually dates back over a 100 years to 1876 to a man named Henry
John Heinz.
Henry was born to German immigrants and was determined to achieve the American Dream.
So, at age 33, he began a small food business with his cousin and brother.
Just like today, Heinz was basically synonymous with ketchup in the late 1800s given that
this was their first product.
While the company performed well under Henry’s leadership, it never became a food behemoth
or anything.
It wasn’t until Henry’s son, Howard, took over and the great depression hit that Heinz
really took off.
You see, when money was extremely tight, Heinz’s ready to eat meals and cheap condiments were
an indispensable part of the average American's diet.
By the time America recovered from the Great Depression, Heinz had become a staple amongst
grocery stores, and it was just a matter of scaling and maintaining their dominance.
In terms of Kraft’s side of the business, their history also dates back 100 years to
1909.
Like Heinz, Kraft was also a family business started by a Canadian immigrant.
James L. Kraft and his brothers started off as door to door cheese salesmen.
Not only were they good salesmen, but they were also phenomenal cheese producers.
In 1916, they figured out a new method to pasteurize cheese that gave their cheese a
significantly longer shelf life.
They went ahead and patented this technique which gave them an edge over the competition,
but when they received an acquisition offer that was too good to refuse, they went ahead
and sold their company to National Dairy Products Corporation in 1930.
The Kraft brand was mainly just a subsidiary for the next 39 years until National Dairy
decided to revive the brand by renaming the parent company Kraftco corporation in 1969.
19 years after this, in 1988, General Mills would acquire the Kraft Brand and they would
hold onto it for the next 19 more years.
It wasn’t till 2007 that General Mills started to sell off Kraft on the public markets which
finally made it an independent company once again.
8 years later, in 2015, the boards of both Kraft and Heinz approved a merger in an attempt
to create a food giant.
But, they ended up creating a food disaster, so what went wrong?
GENERIC BRANDS: Likely one of the biggest factors holding
back Kraft-Heinz is the boom of super retailers like Walmart, Sam's Club, and Costco.
As these guys grow larger, they have started to directly compete with suppliers.
For example, Walmart has Great Value, Sam’s Club has Member’s Mark, and Costco has Kirkland.
If you’re not familiar with these brands, they’re comparable to generic brand medicine.
They basically go out and copy all of the most popular products within their stores.
And, given that such retailers have insane economies of scale and in house production
capacity, they can usually offer the same products for substantially less.
For instance, here’s the official Oreos and Great Value’s Oreos side by side.
While these are basically the same product, Great Value’s offerings are almost half
the cost.
A 19.1 oz packet of Oreos clocks in at $3.98 while a 19.1 oz packet of Great Value Oreos
costs $2.08.
Now of course, many people including myself will always just go with the legacy brand,
but a good portion of people won’t really care.
Not only does this drive revenue away from legacy food brands, but it forces these brands
to be more competitive with price which shrinks their profit margins.
Now, this is great news for consumers, but for name brands who already have meager profit
margins, such competition can easily push them into unprofitability.
Fortunately, Kraft-Heinz themselves have pretty large operations meaning that they can put
up a good fight against generic brands.
But, with that being said, such competition has shrunk their net margins down to the single
digits.
Aside from diminishing margins, the truth is that Kraft-Heinz doesn’t actually have
that much room to grow.
While the company has made several acquisitions to try to continue growth, this hasn’t been
exactly successful.
At the end of the day, Kraft and Heinz are still only known for the two products that
they were founded on cheese and ketchup.
And the problem is that they’ve basically reached market saturation within these sectors.
After all, their products are already dirt cheap and available everywhere in the US,
so anyone who wants these products can easily get them.
Considering this, I don’t think you’d be surprised to hear that their revenue has
flatlined at $25 to $26 billion for the past 6 years.
Their revenue also has basically 0 volatility.
Their best and worst 12 month periods within the past 6 years are within 7% of each other.
And while this may be great for stability, it’s absolutely garbage for growth.
HEALTHY TRENDS: Now, you might be thinking, with the introduction
of in house generic brands, it’s basically impossible to break into the food industry.
And while this is partially true given that the food industry is extremely brutal and
cutthroat, one sector of the industry has been growing rapidly, and that’s healthier
options.
Usually within any market, you have your bougie sector.
With cars, you have Mercedes and Audi.
With smartphones, you have Apple and Samsung.
And with food, you have organic options and Whole Foods.
While this portion of the market is substantially more profitable, the size of this market is
generally much smaller.
If you want to grow the biggest business possible, it’s usually better to target the rest of
the market, and that’s exactly what Kraft and Heinz have both been doing for over a
100 years.
But the problem is that this strategy only works up until a certain point.
Once you’re under a price point which consumers deem fair, they start to make their buying
decision based on other factors like health.
Now, this isn’t to say that the average person is all of sudden strictly buying organic
foods from Whole Foods.
But, the average person has trended towards buying foods with less preservatives, less
processing, and more natural ingredients.
And Kraft-Heinz’s offerings are basically the antithesis to this trend.
In fact, if anything, their products have historically become more processed as they
try to keep up with the prices of generic brands.
Over the past few years, they have shifted their focus onto the health trend.
For example, their newer mac and cheese boxes proudly state that they have no artificial
preservatives, no artificial flavors, and no artificial dyes.
However, this hasn’t been all that successful.
First of all, Kraft-Heinz was late to this trend which gave consumers ample time to find
alternatives.
And secondly, Kraft-Heinz can’t just change their association with processed foods which
has been ingrained in consumers’ minds for literally a century with a simple marketing
campaign.
Likely the best option for Kraft-Heinz was acquiring up and coming brands that aren’t
held back by this association, but they’ve screwed this up pretty badly as well.
INTERNAL AFFAIRS: The first acquisition that didn’t particularly
help the company was the merger of Kraft and Heinz itself.
Not only did Heinz likely overpay for Kraft like Warren Buffett suggested, but there was
really no reason to complete the merger in the first place.
The idea was that Kraft and Heinz could share manufacturing facilities and marketing efforts
in order to lower costs and reach an even larger audience.
But as we just discussed, lower prices aren’t exactly what consumers even want.
So, all this merger did was lock in Kraft-Heinz on a cost reduction journey that didn’t
need to take place.
And to make things worse, given how interconnected the two companies are now, it’s even harder
for them to switch paths compared to if they were just independent companies.
Also, it’s not just me who thinks that this acquisition was not the best.
Kraft-Heinz themselves admit that this was a poor merger which is evident in how they
wrote off Kraft and Oscar Mayer as a $15 billion loss.
This write off was followed by a dividend reduction of 36%, And just when you think
things can’t get worse, Kraft also announced that they were under investigation by the
SEC for their accounting practices.
Unfortunately, this investigation would result in evidence that Kraft-Heinz was indeed engaging
in accounting misconduct.
Between 2015 and 2018, Kraft had recognized unearned discounts from suppliers and maintained
false and misleading supplier contracts.
This allowed them to understate their expenses and overstate their profit.
By the end of the investigation, Kraft had to correct a total of $208 million worth of
bogus cost savings and they were fined a total of $62 million.
During such tough times, you would hope that the leadership at the company was strong and
had a game plan.
But this wasn’t the case either.
In April of 2019, the CEO, Bernardo Hees left the company at the peak of their troubles.
It should also be mentioned that his time as CEO wasn’t that great either.
His legacy at Kraft is literally firing thousands of employees in an effort to cut costs.
So, clearly, Kraft–Heinz hasn’t been doing that great internally or externally for several
years.
BAGHOLDING: Despite all these shortfalls, Warren Buffett
still believes that both Kraft and Heinz are wonderful businesses, and that their main
mistake was simply overpaying for Kraft.
With that being said though, the only reason he still has a position in the company is
because it’s not easy to get out.
Buffett said quote, “We can't as a practical matter move around tens of billions of dollars
that easily.
But beyond that I mean, if we're working with a million dollars or $10 million, would I
have a position in it?
No.”
And I think this tells us everything we need to know about what Buffett really thinks about
the future of the company.
He wouldn’t invest in it right now, but since he already has a position, he’s hoping
to see it through which is quite possible.
It’s been some time since the merger happened and the pandemic started which has allowed
Kraft-Heinz to regain profitability.
Their profits are still low compared to what they used to be which is leading to a high
PE ratio of 67.
But, as their profits continue to recover, this number should only go down.
Also, Kraft-Heinz may be able to bump up their dividend again which could attract a lot more
interest into the stock.
All of these factors could help Kraft-Heinz stock return to their all time highs and potentially
even beat their highs.
But, given all of the underlying issues that we’ve discussed so far, I think Kraft-Heinz
will have a difficult time growing much further than that.
But that’s just what I think.
Why do you guys think Kraft-Heinz is performing so badly?
Comment that down below.
Also, drop a like if you’ve ever had their ketchup or their mac and cheese.
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