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Joining Berkshire Hathaway on Its Recent Fumble

- By Mark Yu

Buying Kraft Heinz (KHC) after its stock price had fallen from its peak earlier this year with an attractive 3.7% dividend yield kicker was a mistake.

Assuming that the company's share price would, at some point, stabilize and recover due to its stable, positive cash flow and significant investment stakes by both 3G Capital and Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), was the key to making this mistake.


Despite recording a near 1% decline in its full-year 2017 revenue, Kraft Heinz reported an earnings beat back in March. The world's largest ketchup and mustard maker also reduced its outstanding debt by $870 million while having provided nearly $3 billion in dividends to its shareholders that year.

To add some confusion, the recent new rule from the Financial Accounting Standards Board made Kraft Heinz's free cash flow appear $2.3 billion less. In fact, there were no significant events that took place in the company's operations that could have made its free cash flow drop by this amount.

3G Capital and Berkshire's $45 billion merger of Kraft and H.J. Heinz in 2015 gave Berkshire 26.7% ownership of Kraft Heinz and 3G Capital a 29% stake.

Fast forward to Kraft's recent quarter performance: The company reported a nearly 2% increase in revenue compared to its year-ago operations but a discouraging 33% drop in profits due to its annual goodwill impairment testing and higher costs.

Per filings, Kraft recorded a $164 million impairment charge in relation to its goodwill assets in Australia and New Zealand and $101 million impairment loss in Brazil. Without these impairments, the ketchup maker would still have delivered a 5.2% decline in profits brought by higher operating costs.

Investor appetite was presumably further reduced when Berkshire's partner 3G reduced its stake by 20.6 million shares out of its 291 million shares in August.

Berkshire, meanwhile, has held on to its 325.4 million shares in the Kraft Heinz. Berkshire has valued its Kraft Heinz investment at $17.9 billion or $55 a share at fair value as of September.

This rough estimation reveals that Berkshire is currently down about 12.3% or $2.2 billion on its Kraft Heinz investment.

Nonetheless, analysts see a 3.3% earnings increase and a 0.8% revenue rise for Kraft next year. Experts also chalked in an average price target of $61 per share versus today's share price of $48.16, indicating near 27% potential upside.

Thinking Kraft Heinz's stock has seen the worst and speculating that it was due for an early recovery, while supplemented by the presence of investment legends, are now recognizable mistakes in terms of returns.

It would have helped to be patient and to have thought about getting in now instead, especially when Kraft Heinz is at its lowest price since starting public trading, or down about 39% since the start of the year, and yielding 5.2% per share.

One can only average down and hope for the best.

Disclosure: Long Kraft-Heinz.

This article first appeared on GuruFocus.