Kraft Heinz faces existential crisis after $16bn rout

Bloomberg

Kraft Heinz Co. might need a new recipe. The packaged food giant reported a troika of bad news — profit that missed estimates, a $15.4 billion writedown on assets and an SEC subpoena — that sent its shares plummeting 27 percent to a record low, a plunge that wiped out more than $16 billion in market value.
It seems to be more than just a bad quarter for the maker of Oscar Mayer hot dogs and Kraft macaroni and cheese. The results raise existential concerns about the investment thesis of a company that was created in a 2015 merger orchestrated by Warren Buffett and 3G Capital, a private equity firm known more for its cost-cutting zeal than its ability to nurture consumer brands.
Two years after the merged Kraft Heinz tried — and failed — to buy Unilever for $143 billion in a deal that would let it continue slashing costs and improving profit margins, it has struggled to boost sales with a portfolio of tired brands, including Capri Sun and Maxwell House. Now, after a massive writedown on assets including the iconic Oscar Mayer and Kraft trademarks, and a profit miss driven by higher-than-expected supply chain costs, questions are emerging about the zealous expense reduction at the heart of 3G’s strategy.
“The cost-cutting mentality is coming back to bite them,” said Ken Shea, an analyst at Bloomberg Intelligence.
“They need to get their house in order.”
INVESTMENT THESIS
When Kraft Heinz was created, analysts wondered where the growth would come with a suite of aging brands, which also includes Jell-O and Kool-Aid. Changing consumer tastes and shopping habits have decimated sales at the largest food companies in the US, as shoppers gravitate to more natural and organic options, rather than pre-packaged and sugar-laden products. But that wasn’t supposed to matter for Kraft.
3G, with support from Buffett’s Berkshire Hathaway Inc., had produced industry-leading margins after taking over Heinz in 2013 and slashing expenses. That was the plan at Kraft, and it worked for nearly two years. The combined company cut $1.7 billion in expenses, beating the target it released when the deal was announced. And investors cheered, with the shares rising north of $90 apiece to trade at a big premium to packaged-food peers.
But after the fat had been cut from Kraft Heinz, management needed another deal so it could start again on improving profit margins. Two years ago, the company made the blockbuster bid for Unilever, and when news of the proposal leaked, Kraft Heinz shares closed at a record high. Since Unilever rebuffed the proposal, though, the Buffett-backed company has been on a steady decline.
Kraft Heinz’s inability to do a big acquisition under Chief Executive Officer Bernardo Hees has put a spotlight on its failure to boost sales. The writedown, essentially a charge to reduce the goodwill value of its biggest-na-me trademarks, was more proof that the company has not managed its brands well, Shea said.
The charges resulted in a net loss of $12.6 billion, or $10.34 a share. The company also slashed its dividend and flagged to investors a subpoena it received last year from the US Securities and Exchange Commission related to its procurement practices.