What’s behind the 27% plunge at Heinz, and how Eric Fry saw it coming

This past Friday, Warren Buffett’s Berkshire Hathaway lost more than $4 billion after Kraft Heinz (in which Berkshire is heavily invested) reported a string of bad news.

Heinz’s stock plunged more than 27% on Friday (and is down another 1% at the time of this writing Monday morning). As you can see below, the drop is a brutal punctuation to an ongoing decline in the stock that’s been plaguing investors for months.

So, what happened?

Basically, everything went wrong. The company didn’t sell as much product as it hoped, it admitted that continued weakness is expected going forward, it had to adjust down the value of some of its most famous brands, and to top it all off, the SEC is sniffing around, looking into Heinz’s accounting practices.

From The Wall Street Journal:

The food giant backed by Brazilian private-equity firm 3G Capital and Warren Buffett’s Berkshire Hathaway announced an avalanche of bad news Thursday, sending shares down 27% in Friday trading.

The company missed earnings estimates, issued weak guidance for 2019, slashed its dividend, took a $15 billion write-down on the value of some of its most famous brands and told investors that the Securities and Exchange Commission is investigating its accounting practices.

***While this news surprised many on Wall Street, it wasn’t surprising to anyone who has been following Eric Fry, editor of The Speculator

It was all the way back on June 30th, 2017 that Eric wrote about the troubles facing many conventional grocery retailers. His analysis resulted in what now appears to be a prophetic recommendation — a put option trade, betting against Heinz.

From Eric, back in 2017:

The “Amazonation” of retail took another giant step forward two weeks ago when the online retail giant gobbled up Whole Foods.

This maneuver was not merely a shot across the bow of conventional grocery retailing; it was a cannonball blast through both the bow and stern. As a result, many former leaders in the sector will start taking on water …

Grocery chains, for example, may not be the biggest victims of Amazon’s newest strategic maneuver. Rather, companies like Kellogg, General Mills, Campbell Soup, and Kraft Heinz may have the most to fear.

The purveyors of branded grocery goods were already under assault before Amazon’s takeover of Whole Foods. But now these companies must defend themselves on multiple fronts at the same time.

Eric goes on to discuss the attack on branded grocers — including private-label substitution, organic product substitution, and online vending.

It’s then that he zeroes in on Heinz in particular. Back to Eric:

Warren Buffett’s Berkshire Hathaway owns 25% of Kraft Heinz, which makes that stock the single largest holding in Berkshire’s investment portfolio. So that’s a very big bet from a very successful investor.

As a general rule, betting against Warren Buffett isn’t simply a bad idea … it’s a terrible idea. But there are a few (rare) exceptions to that rule, and this may be one of them, at least for the moment.

… Kraft Heinz is facing a changing marketplace … and this new marketplace isn’t as welcoming as the old one was. The modern American kitchen, generally speaking, is not as devoted as it used to be to products like Velveeta cheese, Ore-Ida potatoes, Maxwell House coffee and Oscar Mayer hot dogs. So, it’s no surprise that revenue trends in the packaged food sector look just as dismal as the revenue trend at Coca-Cola.

The chart below shows that the recent revenue trend at Kraft Heinz has not been a good one.

… revenues at Kraft Heinz are not growing; they are shrinking. And yet the company’s stock commands a very rich valuation — both in absolute terms and relative to the valuation of its peer group.

Bottom Line: Kraft Heinz is one very pricey stock. Worse, it is the pricey stock of a company that is suffering a serious drop in revenue, while also facing a powerful multipronged assault on its franchise. This is a textbook case of a richly valued stock that is losing momentum.

So, what happened after Eric’s call? Let’s look at the chart.

Eric’s subscribers walked away making 101% on their put options in just four months.

***The timing of Heinz’s collapse last Friday is ironic given my interview with Eric from earlier last week in which he spoke directly to this “Amazonation” of retail

Last Wednesday’s Digest included parts of this interview. From that Digest:

Jeff: On the short side, are there specific sectors you think are most ripe for gains or is it only going to be a company-by-company basis?

Eric: It’s always going to be by company, but in general, the gift that keeps on giving is what I call the Amazonation of retail. We’re seeing right before our eyes, this living, breathing, vibrant example of creative destruction. You have Amazon coming in and creating a whole new way of doing things and then simultaneously destroying a lot of other businesses.

The obvious victim is bricks-and-mortar retail. I mean, those companies are dying one by one by one by one. We’ve already seen a zillion retailers go out of business and they’re going to keep going out of business. So, for instance, when I run screens of return on invested capital, it’s uncanny — the top 100 worst operating companies are littered with retailers. There are so many retailers that are doing so poorly. So, I think that’s ripe territory for short-selling.

Over the weekend, I asked Eric about his thoughts on this latest Heinz news. From Eric:

The stock’s poor performance is hardly a surprise, which is why I started recommending the stock as a short as early as June 2017.

Kraft is one of the sickliest stocks in the sickly packaged goods sector. During the last two years, the shares of General Mills, Campbell Soup, and Kellogg have all fallen more than 20%, despite the fact that the S&P 500 Index gained more than 25% over that timeframe.

As mentioned in last Wednesday’s Digest, Eric’s strategy for profiting from distressed companies involves using options. We provided one example of this in our Digest on February 15, in which Eric helped his subscribers book 75% gains on troubled pharmaceutical company, Teva. You can learn more by clicking here.

***So, what do you do with this information?

If you own the stocks of companies that operate in the branded grocery/packaged goods sector, it’s critical that you give them a hard, objective look. Are your reasons for owning those companies still in place, despite the “Amazonation” of retail?

As the famous quote goes “When the facts change, I change my mind.”

The “facts” as they pertain to the nature of the branded grocery retail sector are changing. Therefore, if you own those stocks, it might be time you changed your mind as well.

Congratulations to Eric on another great call. We’ll continue to keep you up to date on developments in the sector.

Have a good evening,

Jeff Remsburg