Kraft Heinz Sees Solid Q2; Shares Still Offer Upside

Building off its solid start to the year, no-moat Kraft Heinz KHC chalked up accelerating sales (up 7.4% on an organic basis, versus 6.2% in the first quarter) and enhanced profits (adjusted operating margins expanded around 200 basis points to 23%) in the second quarter. The bulk of this growth can be attributed to the ancillary impact of the pandemic, which bolstered sales on its home turf 8.5%, three quarters of its consolidated base, as sales through the retail channel (85% of Kraft Heinz’s mix, up 15% in the U.S.) continued to win out at the expense of a pullback in food-service (down 46%)--with similar marks posted in its Canadian and international operations.

Even though the pace of gains will undoubtedly slow over the next several quarters (as consumers work through their pantries and resort to away-from-home food consumption as social distancing mandates are eased), we don’t believe Kraft Heinz has pushed pause on efforts to steady its ship, as management repeatedly stressed the importance of not losing sight of its turnaround agenda. We still expect its strategic playbook to be anchored in pursuing sustainable efficiencies (versus blindly rooting out costs) as it opts to elevate its brand spending (marketing and product innovation) and enhance its capabilities (category management and e-commerce). However, with its long-awaited investor day now in view (to be held virtually on September 15), details on the underpinnings of its path forward were scant.

As such, we see little in the results to warrant a material change to our $48 fair value estimate and will await more concrete details surrounding its medium- and longer-term objectives before altering our long-term outlook (which continues to call for 2%-3% annual organic sales growth and low-20s operating margins). Despite near-term uncertainty, we still think Kraft Heinz possesses the ingredients to buoy its trajectory and view shares as attractive, trading 30% below our assessment of intrinsic value.

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