Kraft Heinz (KHC) has seen solid momentum since it began trading in early July, with KHC stock up about 7% in that time. And while the industry focuses on cost cutting, the sector continues to be a hotbed of mergers and acquisitions rumors.
Yet there remains one trailing, nagging issue — growth.
This is certainly apparent in the recent second-quarter earnings report for Kraft Heinz: The Kraft division suffered a 4.9% drop in revenues to $4.52 billion because of currency headwinds, as well as overall weakness in the beverages business.
Meanwhile, Heinz suffered a 4.1% drop in sales to $2.6 billion. There also was a negative impact from foreign currencies, in addition to the loss of revenues from the divestiture of a frozen-food business in the U.K.
But the bottom line was another story for Kraft Heinz. The Kraft business booked a profit of $551 million (92 cents a share), up from $482 million (80 cents a share) the year prior. And while Heinz posted a net loss of $164 million, compared to a profit of $127 million in the year ago period, it did enjoy a nice improvement in gross margins, from 32% to 34.2%.
Kraft Heinz unfortunately did not have an earnings call, so it is tough to get much color on the quarter (there will be a listen-only call for bondholders on Friday). The only quote in the press release, which came from CEO Bernardo Hees, was kind of grim:
“The company is focused on the difficult and challenging process of integrating our two businesses. We have a lot of hard work ahead of us as we continue to design our new organization, always putting our consumers first.”
But again, KHC is really a play on aggressive cost cutting. According to the earnings release, the company has been trimming the fat from selling, general and administrative expenses, as well as from advertising spending and manufacturing costs. Going forward, KHC reaffirmed its target of realizing savings of $1.5 billion by the end of 2017.
Keep in mind that Berkshire Hathaway (BRK.A, BRK.B) and 3G Capital Partners LP (a top Brazilian private equity firm) own a combined 51.1% of KHC stock. Of course, Buffett has tremendous understanding of consumer brands, and knows how to generate sustainable gains for shareholders.
But as for 3G, it has taken a much more aggressive approach on cost cutting. As noted in a recent article in the Wall Street Journal, the firm uses zero-based budgeting, which demands rigorous annual plans to find savings. It’s only after these goals are achieved that there is a focus on innovation, product development and growth strategies.
It seems kind of draconian, but it may be the right operating model for mature food operators like KHC. After all, the company has the luxury of benefiting from eight $1bn+ brands, including Oscar Mayer, Jell-O and Velveeta. Besides, it’s natural for high cash-flow companies to get bloated.
But might this ultimately hurt the long-term prospects? Perhaps. Then again, it’s a good bet that KHC will continue its deal-making, which will allow further opportunities to wring out costs and boost earnings. This is probably why billionaire activist investor William Ackman has taken a 7.5% stake in Mondelez (MDLZ) in what appears to be an ultimate play to engineer a merger with KHC.
The deal-making and cost-cutting strategy has certainly paid off with another 3G deal, Restaurant Brands International (QSR). The company is a combination of Burger King and Tim Hortons. And while the innovation has been mostly nonexistent, the earnings have been downright juicy. As result, QSR stock is up about 41% since December.
KHC stock could see further gains, at least over the short-term, and especially if earnings continue to be robust. As for deterioration in revenues, this may just be a secondary concern for investors … at least for now.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
