Last week the stock of the packaged food giant, Kraft Heinz, took a nosedive. The stock fell by 28% on news of a SEC investigation of the companyâ€™s accounting practices but more so the nosedive was due to gigantic losses in the last year. The package food business is very competitive and companies need to balance quality, price, advertising, and new product lines in order to stay competitive as much so as to gain an advantage. What was wrong at Kraft Heinz was that they seem to have lost their way. Cost cutting became the order of the day in order to maintain healthy profit margins. But, consumer tastes are always evolving and old, tried and true products can easily lose ground, especially in an era when everyone wants â€œorganic.â€�
Kraft Heinz was formed just a few years ago in a merger of two companies with hundred-year histories, Kraft Foods and Heinz, the famous ketchup maker. The deal was pushed by none other than Warren Buffett and is a classic Buffett investment. The so-called â€œOracle of Omahaâ€� only invests in companies when he fully understands how they make money and how they will continue to do so for years on end. The company formed by two packaged food stalwarts was a typical Buffett investment and is company, Berkshire Hathaway, owns slightly more than a quarter of Kraft Heinz stock shares.
Management sought to make the company more profitable by cutting $1.7 Billion in â€œexcess costs.â€� And, prior to the recent debacle, Kraft Heinz as returning more per shareholder dollar than competitors like General Mills. That is no longer the case!
The company traded for $80 a share after the merger and from early 2016 to the middle of 2017 rose to the $90 range. Since that time the cost cutting at Kraft Heinz was not working so well as the share price gradually fell to the upper $40 range. Then the bombshell exploded.
CNN reported that Kraft Heinz posted a huge loss and revealed an SEC investigation.
Kraft Heinz wrote down the value of its Kraft and Oscar Mayer brands by $15 billion, posted a $12.6 billion loss, cut its dividend by 36% and announced its accounting practices are under investigation by the Securities and Exchange Commission.
Some pundits have referred to an â€œexistential crisisâ€� for Kraft Heinz. On the other hand, Warren Buffett who holds a fourth of the stock and suffered a loss of more then $4 Billion, says he expects to be holding the stock five years from now. His comment was that management seems to have gotten confused about cost cutting and consumer tastes.
Millennials, Organic Foods, and Amazon.com
A strong â€œselling pointâ€� for Kraft Heinz, General Mills, Unilever, Mondelez International, Nestle, and the like is that they have products with strong brand name recognition. Kraft macaroni and cheese, Heinz ketchup, and Oscar Meyer processed meats have been around for a long, long time. But, does the generation of millennials want these products or something with the label â€œorganic?â€� Now that Amazon.com is running Whole Foods, there is a huge marketing machine pushing organic foods and the convenience that Amazon.com has created with home delivery.
The take home point from what went wrong at Kraft Heinz was probably that they quit thinking about what the consumer wants and thought their product line was golden and would sell forever. So, they focused on cutting costs. It is amazing really how such a large company with so many bright people could have missed this at their stock faltered over the last couple of years.
Beware of a Visit by the SEC
CNBC reported the SEC subpoena.
Kraft also disclosed the SEC subpoena is part of an investigation into its procurement and accounting policies. The company said it launched an internal investigation into the matter after receiving the subpoena. Following its investigation, Kraft Heinz said it posted a $25 million increase to the cost of products sold after determining it was â€œimmaterial to the fourth quarter of 2018 and its previously reported 2018 and 2017 interim and year to date periods.â€�
This may be a minor issue, blown out of proportion due to the huge stock loss and inventory write down. Or it might not be. Kraft Heinz has enough problems right now and does not need to have the SEC on their doorstep. But, that is how it is.
Is Kraft Heinz a Stock to Buy Right Now?
We write frequently about intrinsic stock value and long term investing. When a stock takes a hit but the company still has the ability to generate good profits over the long term, it is a good buy for a long term investor who is willing to wait and whose preferred length of holding a stock is forever. The issue with Kraft Heinz is if they can revitalize their old product line, add new items, spiff up the old ones and do so in such a manner as to bring back sales, profits, and their stock price.
It is of interest that Warren Buffett says that he believes he will holding that stock in five years. That is a good vote of confidence. On the other hand, he might be expected to say that in order to stock the decline of the Kraft Heinz stock price. In the case of Berkshire Hathawayâ€™s investment in Kraft Heinz it will be instructive to see if they buy more of the stock, sell the stock, or simply hold their ground in the coming months.
The concern for long term value investors is that Buffett got it wrong this time around and that Kraft Heinz is now selling at its appropriate price considering the changes in the packed food industry and its aging product line. If that is the case, this is not a stock to buy and wait for bounce or recovery and not a stock to hold for the long term!