On Monday, Kraft Heinz (NASDAQ:KHC) announced that it would have to restate full-year and quarterly results after some of its employees fabricated a number of procurement transactions. The affected results date back to 2016, meaning the firm has more than two years of misleading financial data to answer for. The news hurt Kraft stock, but most of investors’ disappointment was already priced in because the company disclosed the issue back in February.
Source: Mike Mozart via Flickr
KHC was trading at $32.77 per share on Tuesday morning, a 25% drop from this year’s high above $48.
Further to Fall
The big question here is whether this misinformation is a buying opportunity. The fact that the firm has to restate means that its first-quarter results will be delayed this year, which could be putting off another blow to the firm’s share price. The firm broke the news about its accounting issues during its Q4 results, which were lackluster and included a $12.6 billion loss due to a $15.4 billion write-down on its Kraft and Oscar Mayer brands. Plus, Kraft stock cut its dividend by 36% in order to create a little more financial wiggle room … a worrying sign for the future.
Guidance for the first quarter was also poor, with management cautioning that organic sales were likely to decline due to the timing of Easter this year. That means when Kraft does finally come out with its first-quarter results, investors are likely to be disappointed and the KHC stock could take another hit.
Contrarian investors are likely eyeing up Kraft stock as a potential value play and they could be onto something. If the misstatements are as minimal as Kraft management says they are, the worst may be over for KHC stock. The most recent disclosure suggests that the restatement will come in at around $208 million, a figure that management says won’t be “quantitatively material.” If that guidance is correct, it would translate into a less than 1% change to earnings-per-share over the past three years.
The bottom line on the Kraft misstatements is that they don’t look to be significantly damaging to the firm’s financials at this point, so the worst from that angle is likely over.
The real issue for Kraft stock has been growth. The company’s pricing power has diminished over the past few years as consumers look to price rather than brand when it comes to meat and cheese purchases. That has hurt KHC’s finances because that category makes up about a third of the firm’s overall revenue.
Its packaged foods arm has also been hurt by shifting consumer preferences as most opt for healthier, fresh options. In order to counter the softer demand, Kraft has been cutting prices, which has helped keep sales growth positive. However, that has weighed on margins significantly.
KHC also has a debt problem. The firm has been working to pay down its long-term debt, but acquisitions and stalling earnings growth have made that a difficult endeavor. Last quarter we saw long-term debt rise by 9%.
How Risky Is KHC?
Right now, Kraft looks like a very risky play. While the misstatement issues appear to be minimal, the firm has several other headwinds hurting its growth potential. It’s worth noting that long-time Kraft supporter Warren Buffet is keeping the faith when it comes to KHC stock — he told CNBC that despite the financial reporting issues, he hasn’t lost confidence in the firm.
What does that mean for investors considering KHC as a value play? It’s a risky bet, but it could pay off. The huge drop that Kraft stock suffered back in February was due in large part to the news that the firm’s financial reports may not be correct; however, now that the damage has been assessed, it looks like the worst is over.
Of course, the firm will still have to wrestle with the headwinds that were weighing on the stock before the accounting issues were disclosed — and that’s the risk value investors would be taking by snapping up KHC now. However, at just $32 per share and a 4.88% dividend yield, KHC could be a great value buy if you’re comfortable with the risk.
As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.
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