Earnings Preview: Wait for More Clarity Before Buying Kraft-Heinz Stock

It has been a rough run of Kraft-Heinz (NYSE:KHC) stock over the past few years. When Kraft Foods and H.J. Heinz merged in early 2015 to create the fifth-largest food and beverage company in the world, there was a lot of promise and hope that the new mega-food company could leverage synergies to cut costs and boost profits.

Earnings Preview: Wait for More Clarity Before Buying Kraft-Heinz Stock

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But, an over-emphasis on cost-cutting — and an under-emphasis on organic growth — has caused several years of under-performance for Kraft-Heinz stock, which culminated in the stock being the Nasdaq-100’s worst performer in 2019.

At present, there’s hope that new management and a new focus on driving organic growth will power a long overdue turnaround at the company. That’s why Kraft-Heinz stock is up 15% since early September 2019.

But, tread carefully with this rally.

There are still a lot of risks in the Kraft-Heinz growth narrative. The financials remain dour. Growth trends remain weak. And there’s a shortage of resources to fund a big turnaround, meaning that a dividend cut or more asset sales could be coming.

All in all, I wouldn’t chase the rally in Kraft-Heinz stock. Instead, I’d wait on the sidelines for more visibility before turning bullish.

The Growth Narrative Remains Weak

The big problem with Kraft Heinz is that the company’s growth narrative remains weak, and that the outlook for this growth narrative to improve has limited visibility.

Specifically, Kraft-Heinz has a demand problem. Last quarter, organic sales dropped 1.1% year-over-year, on a volume drop of 2.1%, and both of those numbers actually represent an improvement from previous quarters’ numbers. Consequently, the company finds itself with some major, enduring demand headwinds, mostly because the company failed to invest in its product lines for several years, which allowed for smaller independent product lines to gain share.

Now, those smaller independent product lines have a ton of momentum, while Kraft-Heinz’s core product lines are becoming less relevant. In order to reverse this trend, Kraft-Heinz needs to successfully execute some big changes, starting with improving its product portfolio.

But, doing so requires big investments. And the company doesn’t have the resources to fund big investments. Just look at the recent quarterly report. Year-to-date, the sum of the company’s capital expenditures (about $600 million) and dividend payments ($1.5 billion) are greater than the company’s operating cash flow (about $2 billion). So, Kraft-Heinz doesn’t have much “free cash” to work with to execute big operational changes. Where’s the money going to come from?

No one knows. Maybe a dividend cut. Maybe some asset sales. No one really knows.

In it of itself, this lack of visibility is reason enough to shy away from Kraft-Heinz stock at this point in time.

Kraft-Heinz Stock May Not Rebound

Another reason to shy away form this stock here and now is that the valuation isn’t all that cheap.

Ostensibly, the numbers for big upside over the next few years make sense. Consensus fiscal 2022 earnings-per-share estimates sit at $2.65. The average packaged foods stock trades at 18-times forward earnings. Assuming Kraft-Heinz can fetch that industry-average multiple in 2021, then $2.65 in 2022 profit estimates would equate to a 2021 price target of nearly $50.

But, this huge upside potential rests on one major (and risky) assumption — Kraft-Heinz fetches an 18-times forward multiple in 2021.

That may happen. But, at present, it doesn’t look likely. Kraft-Heinz stock hasn’t fetched a multiple that big since 2017. Back then, the company was growing revenues and profits. Today, both revenues and profits are shrinking. And, given the lack of clarity regarding management’s turnaround plan, there’s a lack of clarity with respect to when revenues and profits will stop shrinking.

Until they do, this stock won’t fetch an 18-times forward multiple. Instead, it will continue trade at its three-year-average 12-times forward earnings multiple. Based on that multiple, $2.65 in 2022 profit estimates would equate to a 2021 price target of just over $30. That’s not far above where shares trade hands today.

Bottom Line

At some point in time, Kraft-Heinz’s depressed revenue and profit growth trends will reverse course, the valuation multiple here will expand, and the stock will soar. But, there’s limited visibility as to “when” any of that will happen. So long as turnaround visibility remains limited, I’ll remain on the sidelines.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/02/earnings-preview-wait-for-more-clarity-before-buying-kraft-heinz-stock/.

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