The Kraft-Heinz Investment Thesis Plays Out
When we say that Kraft-Heinz (NASDAQ: KHC) is confirming a reversal we don’t mean the near-term reversal or not just the near-term reversal. The Q3 results confirmed an investment thesis we’ve been tracking for the last few years and has the stock on track for a major upward movement in prices. This reversal is predicated on the company’s turnaround efforts, efforts that are now bearing fruit, and the stock’s deep discount relative to the broad market and its industry peers. Trading at less than 14X this year’s earnings the stock is valued at less than half the industry leaders and pays a significantly higher dividend. In our view, Kraft-Heinz is a foundational-quality investment for long-term dividend growth portfolios and one that could easily return 150% in capital gains along with the safe (and possibly growing) 4.4% dividend yield.
Kraft-Heinz Beats Consensus, Raises Guidance
Kraft-Heinz Q3 was much better than expected if largely due to higher prices. The company reports a 1.5% increase in pricing that was more than enough to count for the 1.3% increase in organic growth. Regardless, the net revenue of $6.32 billion came in 395 basis points better than expected and up 4.1% despite the divestiture of the nut business last year. Analysts had been expecting organic sales to fall 1.7% even with anticipated pricing increases so there is some real strength in the data. On a regional basis, organic sales in the U.S. are up 1.3% and led by a 2.2% increase in the International segment. Canada was the only area of weakness posting -1.9% organic growth. As a side note, the company estimated divestiture cost the business about 400 basis points in growth.
Moving down the report there is some bad news in the margin but the company is working hard to offset them. The gross margin contracted about 420 basis points to 32% despite pricing increases while operating margin widened by 40. This helped drive a 23% YOY increase in GAAP earnings that beat the consensus estimate by $0.03 on a per-share basis. AS for adjusted earnings, adjusted earnings are down about 7% from last year but beat the consensus by $0.07.
Turning to the guidance, the company is expecting organic strength and pricing increases to continue into the coming quarter and has raised the guidance to match their expectations. Management is now calling for flattish revenue growth versus last year compared to the prior guidance for slightly lower and we see upside risk in the numbers. Not only is the company exhibiting organic strength but we are expecting additional pricing increases as well.
The Kraft-Heinz Dividend Is Safe
While we expect to see Kraft-Heinz resume dividend increases at some point in the future it may still be another year or two before that really comes into play. The company is working hard to reinvigorate growth while paying down debt and strengthening the balance sheet and that is tying up FCF. While cash and FCF are down for the quarter the company remains well-capitalized and with ample coverage to continue its plans. When the YOY comps and leverage ratio come back into alignment we’ll start to expect a distribution increase. Until then we are happy with the 4.4% yield.
The Technical Outlook: Kraft-Heinz Confirms A Head&Shoulders
Shares of Kraft-Heinz are up but wobbling in the wake of the Q3 report but the outlook is very bullish. Price action over the past few weeks and months has not only indicated but confirmed a Head&Shoulders reversal that we see taking the stock up the $60 level at least. It may take a little while for the market to build momentum but the fundamental and technical picture has altered for the better. As for the analysts, Pricetargets.com reveals the analysts have yet to get on board this high-yielding, deep-value turnaround story which is all the better for new investment dollars.
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