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Kraft Heinz’s Results Far From 'Ore Ida'

The demise in Kraft Heinz's KHC business persisted into first-half fiscal 2019, as evidenced by dismal six-month results that included a 1.5% decline in organic sales (primarily reflecting lower prices) and a 530-basis-point erosion in adjusted operating margins to 20.3%. While the top line has been weaker than we anticipated (lagging our 0.5% underlying full-year outlook, which management attributed to reduced inventory levels at developed market retailers and unfavorable promotional spend), operating margins aren't far off our full-year mark of 20.5%, as we anticipated continued cost pressures in manufacturing, packaging, and logistics and elevated investments behind its brands would eat into profits this year.

While we intend to reassess the assumptions that underpin our $54 fair value estimate and may shave a low- to mid-single-digit percent off of our valuation, we still believe shares offer a significant margin of safety, especially after the low-teens dip following results. However, we don't expect near-term catalysts to materially narrow the gap relative to our assessment of Kraft Heinz's intrinsic value and suggest investors exercise patience with the no-moat name.

Even though new CEO Miguel Patricio seems to be holding his cards close to his chest for now (reasonable given he's been at the helm for a mere 40 days), we believe his dissatisfaction with its performance and seeming determination to steady the firm's footing may prove to be the ingredients necessary to ultimately buoy longer-term gains. In line with our thinking, Patricio's early read on the business is that it's failed to pivot from one centered on intense cost-cutting (following the merger of the two businesses four years ago) to one anchored in rooting out inefficiencies and boosting brand investments (aligned with our forecast for marketing, research, and development to expand to more than 5% of sales in the aggregate over our 10-year forecast versus less than 5% the last few years).

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