Outsize Sales Gains for Kraft Heinz; Shares Attractive

The outsize sales gains no-moat Kraft Heinz KHC boasted in the first quarter (6.2% on an organic basis, which had been communicated in early April) took a back seat to the implications of the current environment on its strategic direction. Since CEO Miguel Patricio took the helm three quarters ago, the firm has touted the benefits of pursuing sustainable efficiencies (versus blindly rooting out costs) as a means to up the ante on its brand spending (marketing and product innovation) and capabilities (category management and e-commerce). We’ve viewed such investments as a crucial means to aid its sales trajectory and bolster its standing with retail partners, both of which were tarnished under the watch of former leadership. And from our vantage point, management’s rhetoric suggests nothing has changed, stressing the importance of continued spend behind its fixed assets and its brands (unlike others that have been ratcheting back these levels in order to conserve resources).

Although we view its unwavering focus on the long term favorably, we’re less sanguine on the quarter given the bulk of gains were driven by COVID-19-related pantry stocking by consumers (with around 85% of its sales resulting from the retail channel), which shunned away-from-home food consumption amid shelter-in-place mandates. We don’t surmise this growth will persist at the same cadence, as consumers work through their at-home inventory and ultimately venture out to restaurants, and think sales will eventually revert back to the low-single-digit marks that tend to emulate from this mature industry. Further, we expect competitive intensity could increase, especially against a more challenging macroeconomic backdrop. As such, we don’t anticipate altering our $48 fair value estimate or long-term outlook--calling for 2%-3% annual organic sales growth and low-20s operating margins. However, we still view shares, which trade around a 35% discount to our assessment of intrinsic value, as attractive.

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