Kraft Heinz (KHC +2.25%) burned many investors as its stock was cut in half over the past 12 months. In addition to its anemic sales growth and contracting margins, the packaged foods giant struggled with a $15 billion writedown, a dividend cut, an SEC probe regarding its accounting practices, delayed SEC filings, and a CEO change.
Even Warren Buffett, Kraft Heinz's top investor via Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), admitted that he had "overpaid" for the stock. Berkshire still holds a 27% stake in Kraft, but Buffett has repeatedly stated that the company has "no intention" of selling its shares.
Image source: Getty Images.
However, Kraft's second largest investor, the Brazilian private equity firm 3G Capital, recently disclosed that it had sold 25.1 million shares at an average price of $28.44 for $714 million, which reduced its total stake to about 20%. Should investors consider that sale a bright red flag?
Untangling Berkshire and 3G's disastrous project
Berkshire Hathaway and 3G Capital engineered the merger of Kraft Foods and Heinz, which closed in 2015 and created the world's fifth-largest food company.
At the time, Berkshire and 3G believed that the combination would create a more competitive company that would boost shareholder value. Instead, it struggled with shifting consumer tastes and tough competition from healthier and private-label brands.
Instead of countering those headwinds with innovative new products, takeovers, and marketing campaigns, Kraft Heinz's management -- which was installed by Berskhire and 3G -- focused on cutting costs to boost its profits. As a result, Kraft's unit sales and revenue growth flatlined.
Kraft's rival General Mills (GIS +1.18%), which also struggled with anemic sales growth, hiked prices to offset its lower unit sales. Kraft, however, slashed prices to prop up its sales growth, which crushed its margins:
|
Metric |
Q2 2018 |
Q3 2018 |
Q4 2018 |
Q1 2019 |
Q2 2019 |
|---|---|---|---|---|---|
|
Organic sales (YOY) |
(0.4%) |
2.6% |
2.4% |
(2.8%) |
(0.3%) |
|
Adjusted EBITDA margin |
29.5% |
25.3% |
24.7% |
24% |
25% |
YOY = Year-over-year. Source: Kraft Heinz quarterly reports.
Kraft finally reversed its sequential margin declines last quarter as its new CEO Miguel Patricio gradually raised prices again. However, Patricio is still sticking with his predecessor's "zero-based budgeting" strategy, which cuts spending in other areas to free up cash (instead of allocating fresh capital) for new R&D and marketing initiatives. Patricio also stated that he wasn't interested in divesting any more units or buying other companies.
Image source: Getty Images.
In other words, reducing Kraft's massive debt load of nearly $30 billion is still the company's top priority, and its turnaround initiatives must be funded with the savings generated by cost-cutting initiatives in other areas. That plan doesn't inspire much confidence.
Does 3G Capital still believe in Kraft Heinz?
3G states that its sale was sparked by liquidity needs for its fund's investors instead of a lack of confidence in Kraft Heinz's future. 3G previously reported a similar sale of 20.6 million shares at an average price of $59.85 last August. In an apparent attempt to assuage investor concerns, 3G founder Jorge Paulo Lemann boosted his personal stake in Kraft Heinz by about $100 million -- but that purchase still won't offset 3G's massive sale.
A core problem is that 3G Capital's main strategy for dealing with companies -- including AB InBev and Restaurant Brands International's Burger King, Tim Hortons, and Popeyes Louisiana Kitchen -- is to aggressively apply zero-based budgeting tactics.
Those tactics work if a company's brands are still strong, since it squeezes out higher profits from rising revenues. But if a company's brands are weak and its revenue growth has flatlined, cutting costs exacerbates the problem and cripples turnaround efforts. Therefore, it's safe to say that 3G's vision for Kraft didn't pan out, and it's likely the firm is losing confidence in the troubled company.
Is this a red flag for investors?
Kraft Heinz investors shouldn't sell their shares based on 3G's move alone, but it's definitely another red flag in a field of red flags. Kraft's forward P/E of 11 and forward yield of 5.5% might limit its downside potential at these levels, but Buffett's comments and 3G's sale indicate that a recovery won't happen anytime soon.
