Almost two years ago to the day, packaged foods giant Kraft Heinz pulled its ultra-ambitious $143 billion unsolicited bid for Unilever, after the Berkshire Hathaway and 3G Capital-backed company decided against pressing a hostile takeover effort.
With hindsight, the quick reversal by Buffett and 3G Capital’s leadership was wise. Kraft Heinz, after all, is struggling to make the strategy that brought together Heinz ketchup and Oscar Mayer hot dogs work.
On Thursday evening, shares in the heavily indebted company plunged nearly 20% after it revealed a trifecta of issues: A $15.4 billion writedown, a Securities & Exchange accounting probe and a tepid 2019 outlook that means its dividend is getting cut by 36%. Part of the problem for Kraft Heinz is its global footprint, which proved challenging as profits were hit by cost inflation related to tariffs, and the company’s own supply chain issues. But the bigger issues are its debts and struggles to grow old brands as consumer tastes change.
Kraft reported fourth-quarter net sales of $6.9 billion, up 0.7% year-over-year and a $12 billion net loss due to a massive goodwill impairment in North America related to the value of its Kraft and Oscar Mayer trademarks. Excluding the writedown, adjusted profits were $1.7 billion, a 14% drop that fell short of company forecasts.
Kraft Heinz CEO Bernardo Hees, a partner at 3G, put a brave face on the results.
“Our fourth quarter and full year 2018 results reflect our commitment to re-establish commercial growth of our iconic brands,” Hees said, in addition to turning around underperforming businesses. “We are pleased with those actions, the returns on our investments, and the momentum built for 2019. However, profitability fell short of our expectations due to a combination of unanticipated cost inflation and lower-than-planned savings. Going forward, our global focus will remain on leveraging our in-house capabilities, developing our talented people, and delivering top-tier growth at industry-leading margins.”
Then came the bad news.
In October, Kraft was subpoenaed by the Securities & Exchange Commission due to an investigation into its accounting and internal controls on procurement, and how it negotiates modifications to its agreement with vendors. The company increased its cost of products sold by $25 millio, but says it doesn’t expect material changes to its financials. It is implementing improvements to its controls and continues to cooperate on the SEC’s investigation, Kraft Heinz said. It’s important to note, Kraft Heinz has industry-leading margins and working capital management but little to show in the way of organic growth.
In an investor presentation, Kraft also offered up a hazy outlook for investors who’ve seen the company’s stock fall from the $80s in mid-2015 to below $40.
First-quarter organic sales growth will be offset by divestiture and currency headwinds, and an unfavorable calendar. Adjusted profits for 2019 are expected to be in the range of $6.3 billion to $6.5 billion due to increased marketing and e-commerce spending and commodity cost inflation. For the first quarter, adjusted profits are expected to plunge nearly 20%. These are troubling declines for a company with nearly $31 billion in long-term debt.
Once among Wall Street’s weightiest and most feared acquirers, Kraft Heinz now has a new tune for investors. It’s selling assets, cutting leverage and reducing dividend payouts (now down to $0.40 a quarter from $0.625).
For Kraft Heinz’s backers, the change of course and circumstances has been painful. A year ago, Berkshire Hathaway’s 325 million Kraft Heinz shares were worth $25 billion, meaning Warren Buffett was sitting on $15 billion in gains from having partnered with 3G Capital to buy Heinz and then Kraft Foods. Now after a halving of Kraft Heinz stock in a year, the gains are all but gone and Berkshire’s shares are worth just over $12 billion.
If there’s any solace for Buffett and 3G, it could have been much worse.
Imagine an extra $100 billion in debt from Unilever and added headaches with an already troubled business model. CEO Hees and CFO David Knopf, an alumni of Forbes’ 2017 30 Under 30 list in finance, professed to investors that they have a handle on the company’s issues. In 2020 and beyond, after delevering, they expect to be talking about revenue and profit growth anew.