Is Kraft Heinz still a Value Investment?

Observers are asking; “is Kraft Heinz still a value investment,” because Warren Buffett himself is bad mouthing the company.

“I was wrong in a couple of ways on Kraft Heinz,” Buffett told CNBC television in February. “We overpaid for Kraft.”

Buffett’s attitude is strange, because Berkshire Hathaway (NYSE: BRK.A) and 3G Capital created the Kraft Heinz Company (NASDAQ: KHC) in 2015. To explain, the two firms merged Berkshire Hathaway (NYSE: BRK.B) subsidiary J.J. Heinz with Kraft Foods, Reuters reports.

Consequently, Berkshire owns 26.7% of Kraft Heinz which is the publicly traded company linked to as a Berkshire subsidiary at the BH website. However, Buffett is still standing by Kraft Heinz.

Does Buffett think Traditional Brands are Dead?

“If I had to bet one way or another, I think people will eat more of our products this year than last year,” Buffett says of Kraft Heinz. However, Buffett admits Kraft Heinz’s historic brands cannot compete with private label products from deep discounters like Costco Wholesale (NASDAQ: COST).

Buffett himself estimates Costco’s Kirkland private label outsells all of Kraft Heinz’s brands. Uncle Warren estimates Kirkland’s 2018 sales at $39 billion.

Meanwhile, Kraft Heinz recorded $26.27 billion in annual revenues for 2018, Stockrow reports. Thus, Kirkland is worth more than Kraft Heinz’s entire stable of historic bands.

Notable Kraft Heinz Brands include Oscar Meyer, Kool-Aid, Planters Peanuts, Maxwell House Coffee, Bakers Chocolate, Heinz 57 Sauce, Velveeta, Grey Poupon mustard, Ore Ida Potatoes, and Capri-Sun. Kraft Heinz’s most valuable assets its brands are losing most of their value.

Why are Brands Losing their Value

To understand why brands like Oscar Meyer are losing most of their value we must understand how the retail market has changed.

Manufacturers created brands back in the 19th and 20th Centuries because the retail system was completely fragmented. Back in 1890 or 1910 there were no national retail chains or brands.

Instead, the country store or neighborhood market was a true independent business. Consequently, it was often hard to guarantee the quality of the products in the store. Shoppers, had no way of knowing what Mr. Hooper actually put it in his sausage, or what he was adding to the coffee.

Maxwell House and Oscar Meyer solved that problem by putting their label on foods and guaranteeing the products. When you traveled from town to town, you could tell if the products were good because they carried the national brand.

How Brands Have Lost Their Value

However, in today’s world, most of us shop at giant corporate stores where management has a strong incentive to guarantee the quality of everything on the shelves. Consequently, there is no reason for a brand.

As a result, today’s shopper is more interested in price than the brand. Grandmother always Planters Peanuts because she trusted the brand. Today, I buy Kirkland peanuts because they are cheap and high quality.

Moreover retailers like Costco, Walmart (NYSE: WMT)Kroger (NYSE: KR), and Aldi have a strong incentive to throw Kraft Heinz brands out of their stores. Retailers make more from private label because they own the brand and control the price.

In fact, retailers like Aldi and Trader Joe’s stock mostly private label to ensure the lowest price possible. Aldi and Costco can undercut almost every other retailer in town because they stock mostly private label brands.

Americans Now Buy Private Label

Thus, Kraft Heinz faces the nightmare of a distribution system rigged against it. Moreover, a large percentage of shoppers grab the store brand (private label) because it is usually the cheapest and just as good as the national brand.

Notably, we now have two large generations of shoppers; Millennials and Generation Xers, who grew up shopping at Walmart and Costco. Pew Research now estimates Millennials (those born after 1981) are now America’s largest generation with 73 million members. Meanwhile, Generation X born 1965 through 1980 numbers 51 million.

Thus, Kraft Heinz brands are a very hard sell to the majority of today’s shoppers. Today’s young mother fails to reach for Ore Ida because she never bought it in the first place.

To make matters, most of today’s retailers deliberately stock merchandise to discourage buying of other brands. For instance, they fill end caps with the store’s private label products instead of Kraft Heinz brands.

What Value Does Kraft Heinz Have?

Thus, Kraft Heinz’s value is very questionable right now. Notably, the company has not reported quarterly revenues since December 2018.

Back then, Kraft Heinz reported a $6.9 billion quarterly revenue. Disturbingly, Kraft Heinz is losing a lot of money. In fact, the company reported a -$12.57 billion quarterly net loss on New Year’s Eve 2018 and an operating loss of -$14.1 billion on 29 December 2019.

However, Kraft Heinz recorded an operating cash flow of $1.675 billion and a free cash flow of $1.443 billion on 28 December 2019. Thus, Kraft Heinz is generating some cash but no income.

Kraft Heinz pays a Dividend

Interestingly, Kraft Heinz reported $1.113 billion in cash and equivalents on December 29, 2018. Thus, Kraft Heinz can make some money despite its problems.

Oddly, Kraft Heinz paid a dividend of 40₵ on 14 June 2019. However, that dividend was down from 62.5₵ paid on 14 December 2018. Oddly, Kraft Heinz looks like a decent dividend stock because shares were trading at $31.25 on 3 July 2019.

Consequently, Kraft Heinz shareholders received a dividend yield of 5.15%, an annualized payout of $1.6 and a payout ratio of 43.1% on July 3rd 2019. Plus Dividend.com credits Kraft Heinz with five years of dividend growth.

Kraft Heinz is a Lousy Stock with a lot of Potential

My opinion is that Kraft Heinz is a lousy stock with a lot of potential. The company, still pays a good dividend even though it loses a lot of money.

Oddly, I think there is growth potential at Kraft Heinz because of the internet. To explain, I think Kraft Heinz brands like Oscar Meyer could be valuable if the company could sell them directly to consumers through platforms like Amazon (NASDAQ: AMZN) and Instacart.

For instance, Kraft Heinz could participate in Amazon’s Prime Fresh by stocking its products directly in the Amazon fulfillment center. The Prime Fresh delivery truck will take the hot dogs, ketchup, etc., to the customers.

Could Instacart or McLane save Kraft Heinz?

Additionally, Kraft Heinz could sell directly to Instacart, perhaps by renting space in stores where Instacart contractors will pick up the items.

Another solution is to set up mini warehouses in empty spaces at malls or strips. Instacart drivers could pick up orders from a mini warehouse in an old storefront for instance.

However, Kraft Heinz will have to develop its own distribution network. Perhaps, another Berkshire Hathaway subsidiary McLane; which distributes food to thousands of convenience stores, discount stores, and restaurants, could solve that problem. To explain, McLane could distribute Kraft Heinz products to local facilities for Instacart drivers to pick up.

 Why Amazon should Buy Kraft Heinz

In the final analysis, there is a lot of untapped value at Kraft Heinz, however nobody knows how to tap that value. Though there are possibilities including selling Kraft Heinz to a retailer like Kroger or Amazon.

I think Kraft Heinz’s brands could be a great addition to Amazon’s ecosystem. Instead of private label; only Amazon could sell favorites like Heinz 57 and Kraft cheeses. Likewise, Kraft Heinz could become an exclusive private label for Instacart.

I advise only investors with a high tolerance for loss, and money to burn to buy Kraft Heinz (NASDAQ: KHC). I advise everybody else to stay away from this stock until Warren Buffett figures out what to do with it.