Heinz was bought out by 3G Capital in 2013, with the new owners focused on cutting costs. That’s the playbook that 3G Capital is known for, championing so-called “zero-based budgeting.” The goal is to reduce costs to improve profits. Heinz then bought Kraft in 2015, creating Kraft Heinz (NASDAQ:KHC), and started looking for even more fat to trim. The problem is that this business approach hasn’t performed nearly as well as expected for the company or investors.
Kraft Heinz recently came out with a different plan — will this one work?
A tough business
Consumer staples stocks like food makers tend to be fairly stable businesses built around iconic brand names, broad distribution systems, and significant advertising might. Effectively, the major players own the brands you know by name and have the reach to get them into the places you shop. There are a lot of companies in the space, and competition can be fierce. Missing a trend or lagging behind a new industry development can have devastating consequences. Look no further than General Mills (NYSE:GIS) for confirmation of that, as its Yoplait yogurt brand lost important market share when the company didn’t jump on the Greek yogurt craze.
General Mills’ yogurt sales fell 7% in fiscal year 2016, 18% in 2017, and finally hit a nadir in the first quarter of fiscal 2018 when Yoplait sales fell a painful 22% year-over-year. In those last two periods, the company lost 3.8% and 3.5% of its yogurt market share, respectively. It was a difficult period, but General Mills was able to turn things around, slowly, with new and innovative products. That included tapping into new yogurt trends that were emerging and investing in the marketing to support its products. General Mills effectively had to spend money to make money in a competitive market. While it wouldn’t be fair to suggest that the business has been turned into a growth engine, management has at least stabilized the division.
When 3G bought Heinz in 2013, it didn’t focus on investing in the business to build it — it focused on taking out costs. Big companies do, often, have bloated expenses, so aggressive cost cutting can look attractive in the near term. That’s not a bad thing in and of itself, but a company can’t save its way to long-term growth, because at some point all of the cost cutting starts to reduce a company’s competitiveness. And in a competitive market like packaged foods, major players can’t afford to have a myopic focus on cost cutting to the exclusion of everything else.
Looking for more
Indeed, cutting costs at Heinz initially looked like a winning plan, so much so that Heinz bought Kraft looking to give itself more runway for its cost-cutting efforts. But the downside of the plan started to catch up on the company, as cost cutting started to take a toll on its core business. For proof of that, look no further than the company’s fiscal-year-2018 financial results, in which it took a $15.4 billion one-time charge, most of which was to write down the value of the Kraft and Oscar Mayer brands. Kraft is the company’s namesake brand! This was basically an admission that, just a couple of years after buying Kraft, the plan wasn’t working. Investors punished the stock, sending it lower by as much as 27% on a single day.
In fiscal 2019, which ended in February of 2020, things didn’t get much better. In the earnings release, CEO Miguel Patricio summed things up by stating, “While our 2019 results were disappointing, we closed the year with performance consistent with our expectations, and driven by factors we anticipated.” The company reported more write downs, though not nearly as large, and noted that it was looking to invest in its brands — a potentially important shift in focus.
In mid September it finally announced a strategic transformation plan, with an impressive 274-page investor presentation to back it all up. In the end, the plan looks to be a mix of good news and some potentially troubling news. On the bright side, the company appears to have renewed its focus on growth. That includes increasing advertising spending by 30% and reworking its divisions to focus on customer needs and desires. The latter, will, hopefully include a healthy dose of product innovation.
However, an effort to remove another $2 billion in costs out of the company is another key goal. The stated intention is to use those cost saving to help fuel the company’s growth initiatives, which sounds wonderful. However, cost cutting hasn’t worked out too well so far for investors. There’s good reason to be leery about that particular piece of the puzzle.
The company is also trimming down by selling brands, including iconic names like Breakstones, Polly O, and Cracker Barrel. Although the sale of these cheese brands will net Kraft Heinz $3.2 billion that can be put toward debt reduction and investing in the rest of the business, having notable brands in the packaged food sector is vital. Jettisoning well known brands like these might lead one to think that the company doesn’t know what to do with them, doesn’t have the time or money to turn them around, or is getting a bit desperate and needs to raise cash as quickly as possible so it can save other brands it views as more important. None of these are particularly inspiring thoughts.
All in all, it’s good that Kraft Heinz has a plan. It’s good that the plan openly recognizes the need to invest in the company. But the continued focus on cost cutting is more than a little worrying, since that plan hasn’t worked out well so far.
Wait and see
Kraft Heinz investors have suffered a dividend cut and a roughly-70% price decline from the highs reached in 2017. The 3G cost cutting approach has not paid off particularly well. The company’s new game plan looks like it’s moving in a much better direction, but long-term investors should tread with caution here. Sure, this time might be different, but it’s probably best to take a show-me approach. Selling brands and cutting $2 billion in costs sounds an awful lot like the old way of doing things, and that could easily upend even the best-intentioned growth plans. Most investors looking at Kraft Heinz would probably be better off with a company that is focused more intently on innovation, like General Mills — or, given that it normally fetches a premium price, meat-focused Hormel.