Kraft Heinz Co. represents all that is wrong with aspects of corporate America. So why does Warren Buffett like the stock?
The U.S. markets and economy may be holding up, but there’s a corner of the business world with an unsettling combination of factors: few growth opportunities, resistance to new customer trends, ruthless cost-cutting to make up for revenue shortfalls, a willingness to do high-stakes deals that whiff of desperation and an increasing comfort with eye-popping levels of debt. Kraft Heinz is most emblematic of this.
On Friday, the $78 billion food conglomerate reported second-quarter sales and earnings that beat expectations, and that of course had shareholders cheering. But a closer inspection of the results shows that Kraft Heinz has made little headway in making its products more appealing to modern grocery shoppers, who are seeking fresher, less processed and more nutritious options —demand that probably isn’t going away. Instead, the company’s big ideas are things like tinkering with ways to push Lunchables and bringing back Planters Cheez Balls, not quite addressing broader consumer trends.
Kraft Heinz said total company sales rose 0.7 percent in the quarter, though growth was negative excluding currency and deal benefits, even in the face of price increases. U.S. revenue fell nearly 2 percent. International regions posted strong gains, but they carry little weight in a business that relies on North America for more than three-quarters of its revenue and Ebitda.
While Kraft Heinz could — and probably will — go deeper into debt to do a synergistic megamerger in a roundabout way of boosting profit, that doesn’t get to the root of the problem. In fact, according to the New York Post, Kraft Heinz already has its eye on the beleaguered Campbell Soup Co., which if true is a sign that the company still isn’t prioritizing the sort of sustainable, long-term growth favored by investors like Buffett. It’s a surprise that Buffett’s Berkshire Hathaway Inc. is still Kraft Heinz’s No. 1 shareholder, and it’d be even more surprising if Berkshire helps bankroll the next deal. (Remember, Berkshire helped finance 3G Capital’s buyout of H.J. Heinz in 2013 and the merger two years later of Heinz and Kraft Foods. Berkshire itself is scheduled to report second-quarter results Saturday morning.)
Borrowing at Kraft Heinz remains quite high, while Campbell Soup also faces a mountain of debt following a desperate deal for snack maker Snyder’s-Lance earlier this year, which was orchestrated by a CEO who left abruptly soon afterward. Campbell is still searching for a permanent successor and has reportedly found itself targeted by activist investor Dan Loeb’s Third Point LLC in the meantime. Like Kraft Heinz, Campbell gets most of its revenue from the U.S., and its most well-known products have waned in popularity. It really doesn’t check any boxes for Kraft Heinz except that it would allow the private equity managers from 3G to take a razor to the business’s costs, particularly overhead such as employees. Still, I don’t see the appeal of a deal or why Buffett would support that strategy.
Kraft Heinz has been a good investment for Berkshire because of how the transactions were originally structured: Berkshire received a whopping $720 million a year in dividends — a 9 percent yield — on preferred stock, which Kraft Heinz then redeemed at a premium for $8.32 billion two years ago. It was a sweet deal. And even though Berkshire and 3G seemed like an odd duo from the start, Buffett always explained it away. He’d say Berkshire buys businesses that are already lean and that’s why it doesn’t need to meddle with them much, whereas 3G buys businesses that it must make leaner. But now it’s getting harder to justify Buffett’s involvement in a company that in some ways goes against what he preaches about taking a long-term view and creating value for years to come.
The billionaire, who turns 88 this month, already stepped down from Kraft Heinz’s board, ostensibly to reduce his travel commitments, though it could also be a precursor to winding down the $20.8 billion position. So much of the faith in Kraft Heinz’s management is due to Buffett’s support, so without him investors may look at the company in a different light. Even if Buffett remains intrigued, it’s hard to imagine his eventual successor and investing lieutenants — who are responsible for decisions like buying Apple Inc. stock — would hang onto this one when Buffett is no longer in the picture.
Kraft Heinz skated through another quarter despite lackluster performance. But now may be time to start bracing for the day it loses the Buffett factor.
Tara Lachapelle is a Bloomberg Opinion columnist covering deals, Berkshire Hathaway Inc., media and telecommunications. She previously wrote an M&A column for Bloomberg News.
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