Kraft Heinz Earnings: Its Surgical Pursuit of Cost Savings to Fuel Brand Investments Buoys Results

Even though the sun is setting on CEO Miguel Patricio’s time at the helm of no-moat Kraft Heinz KHC, we surmise the imprint he is leaving on the business will persist. Before he came on board, Kraft Heinz was plagued by its outsize desire to root out costs blindly in favor of juicing near-term sales and cash flows, without any regard for investing to support the long-term health of the business. In stark contrast, Kraft Heinz’s third-quarter results (1.7% organic sales growth, nearly 400 basis points of expansion in the adjusted gross margin to 34%, and a 280-basis-point jolt in the adjusted operating margin to 17.7%) came in spite of a 25% increase in marketing expense, an 8% bump in research and development expense, and a 24% increase in technology spending. And we think management is keen to unearth further cost savings to boost spending behind its brands and capabilities, with incoming CEO Carlos Abrams-Rivera (one of the architects of this playbook) set to take the reins.

But beyond this, we also think Patricio and his team have judiciously prioritized debt paydown, with net leverage falling below its 3 times target a year ahead of plan. When combined with its robust cash generation (free cash flow averaged in the midteens as a percentage of sales the last three years—levels we think can hold over our forecast), we posit this should unlock opportunities for enhanced financial flexibility to beef up its return to shareholders (in addition to investing in its existing operations), with our forecast calling for mid-single-digit increases in its annual dividend in short order.

With just two months left in its fiscal year, our $53 fair value estimate shouldn’t see much change outside of time value nor should our long-term outlook for 2%-3% annual sales growth and low-20s operating margins. Despite a mid-single-digit bump on the print, we view shares as attractive, trading at a 40% discount to our intrinsic valuation while offering a 4%-plus dividend yield.