Kraft Heinz Is Shrinking to Fit Its Dividend

Yield was the reason Kraft Heinz (NYSE:KHC) was created. Yield is why KHC stock is now shrinking.

A magnifying glass zooms in on the Kraft Heinz (KHC) website.

Source: Casimiro PT / Shutterstock.com

The company was put together by Warren Buffett of Berkshire Hathaway (NYSE:BRK.A) and Brazil’s 3G Capital Management in 2013. The idea was to cut costs in popular packaged-food brands through “zero-based budgeting,” where all spending must be justified every year, then pull out cash in the form of dividends.

This is an approach that has worked great at Restaurant Brands International (NYSE:QSR), another 3G-Buffett collaboration. QSR is up 89% since that deal was announced and delivers steady dividends.

Since it was put together, however, Kraft Heinz stock is down almost 50%. The zero-based approach has starved it of capital. Now, to protect the dividend, it’s being broken up.

Selling the Pieces

The latest step is an agreement to sell its Planters Nuts business to Hormel (NYSE:HRL) for $3.35 billion. The business represents about 16% of last year’s $6.9 billion of revenue, or $1.1 billion.

While analysts focused on what the deal means for Hormel, it’s the second big deal in a year for Kraft Heinz. It sold a bunch of its cheese brands, including Breakstone’s and Cracker Barrel, to France’s Lactalis Group in September for $3.2 billion. Those operations represented $1.8 billion of revenue and included some Kraft cheese-naming rights. (Don’t worry. They’re keeping Velveeta.)

Kraft Heinz called 2020 a “transition year,”  but it’s more like a “clean-up on aisle 5.” The company wrote off $19.4 billion in assets in 2019 and suffered an accounting scandal that cost CEO Bernardo Hees his job. His replacement, Miguel Patricio, was brought in from another 3G investment, AB Inbev (NYSE:BUD). The 3G stake in Kraft Heinz also fell to 20%.

What’s Left

What’s left is a dividend yielding 4.5%, which, if sustainable, should attract income investors. But KHC stock is not a place to go to for capital gains, and value stocks are out of favor. Analysts at Tipranks expect a gain of just 7.13% on the equity this year, with just three of eight suggesting it’s a buy.

The dividend is sustainable thanks to free cash flow, which hit $5 billion last year. The company has cut long-term debt by $2.3 billion in the last year, and the dividend costs it $2 billion a year to service.

That dividend is down, however, from a pre-scandal payout of 62.5 cents per share.

To keep the dividends flowing, the company has been doing brand extensions, cutting the total number of brands it supports. It has also been cleaning up its packaging, replacing plastic rings with cardboard.

Patricio talks about having six “platforms,” with “taste elevation” (think ketchup) and “easy meals made better” (think mac ‘n cheese) getting more investment, and “indulgent desserts” (think Jell-o) getting less.

The Bottom Line on KHC Stock

The last quarter counted as a beat with analysts. Bears worry about whether pandemic-fueled gains in “center of the grocery” items will continue after the pandemic ends.

But this is a value stock, not a growth stock. You buy it for income, and trust that Patricio can keep the dividends coming.

Right now, this management approach is out of fashion. Kraft Heinz stock is up just 2% since the year started, despite the earnings beat and the Planters sale.

If risk-on becomes risk-off, however, Kraft Heinz will look good. Its remaining business has stabilized, and it’s profitable. The dividend yield, while lower than that of, say, Exxon Mobil (NYSE:XOM) or AT&T (NYSE:T), looks more reliable than theirs do.

KHC stock, in short, won’t make you rich. But it will keep you from becoming poor.

At the time of publication, Dana Blankenhorn directly owned shares in T.

Dana Blankenhorn has been a financial journalist since 1978. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Follow him on Twitter at @danablankenhorn 

 


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