The Kraft Heinz Company (NASDAQ: KHC) and Mondelez International (NASDAQ: MDLZ) are home to iconic grocery brands, but both companies have struggled to find meaningful growth lately due to a sluggish sales environment throughout the industry. However, both management teams are focused on what they can control by cutting unnecessary costs, boosting earnings performance, and continuing to innovate with new products which lays the groundwork for growth to resume once consumer demand returns.
Let's review the basic investment case for each to determine which of these two dominant food giants is the better buy.
The case for Kraft Heinz
You really can't talk about the merits for investing in Kraft Heinz without mentioning Warren Buffett, who sits on the board of directors, and whose Berkshire Hathaway owns 26.7% of Kraft Heinz shares. In 2015, Berkshire Hathaway and 3G Capital (of Anheuser-Busch Inbev fame) partnered in a deal to bring the former Kraft Foods and H.J. Heinz under one roof. Combined, Berkshire and 3G own more than 50% of the stock, essentially controlling the company.
Kraft Heinz is the quintessential "Buffett" stock. The company's competitive moat is built on household name recognition of major grocery brands, including Kraft Macaroni & Cheese, Planters, Jell-O, Maxwell House, Velveeta, Oscar Mayer, and Kool-Aid. On the Heinz side, the famous ketchup brand also owns a vast range of international food brands, which all together help Heinz generate about 60% of its sales outside of North America.
Over the last few years, management has been following the typical playbook of 3G Capital by cutting unnecessary costs and improving existing brands with better marketing and innovation. Sales growth has been slow lately -- which has been the case throughout the industry -- with Kraft Heinz's 2016 organic net sales moving at a snail's pace of 0.3%. On the bottom line, however, better cost management led to a huge boost in earnings per share of 52.1% (excluding currency and costs associated with the merger in 2015).
Unlike Heinz, North America makes up 98% of Kraft's sales, which creates a significant growth opportunity for Kraft to expand its key brands to new consumers throughout the world. Additionally, with 3G Capital influencing the company's direction, investors should be on alert for potential acquisitions in the future. Management already made a move for Unilever earlier this year, and rumors are already swirling as to what company Kraft Heinz will attempt to court next.
The case for Mondelez International
Mondelez may not be a recognizable name, but its brands certainly are, which include Oreo, Cadbury, Trident, Milka, and Nabisco. Besides strong brands, Mondelez possesses an important competitive advantage from its vast direct-store-distribution network, which allows the company to roll out new products and respond to shifts in consumer demand in a very timely manner.
Mondelez's revenue and earnings growth has been a very similar story to Kraft's. In 2016, organic net revenue grew only 1.3%, but adjusted earnings grew much faster at 24.1%. This highlights an interesting phenomenon taking shape in the food and beverage industry right now. Because 3G Capital has been so successful gobbling up major food and beverage brands over the last 10 years, some of the other major food companies, including Mondelez, are following the same playbook -- slashing costs, improving margins, and innovating -- in order to satisfy shareholders and avoid being acquired.
Mondelez has responded to lower demand for sugary snacks by introducing new products that are marketed for their simpler and "healthier" ingredients. While consumers don't desire as much sugar these days, they still like the convenience of snacking, which puts Mondelez in a good position to find growth once again as it introduces new products like Vea, GOOD THiNS, and belVita that exclude the ingredients health experts have suggested are detrimental to your health, such as high-fructose corn syrup and hydrogenated oil.
Dividends and valuation
As for valuation, Kraft Heinz is more expensive with a trailing price-to-earnings ratio of 24 compared to Mondelez's 21. On the other hand, income investors may prefer Kraft's 2.8% dividend yield, which is higher than Mondelez's 1.7% yield.
Both companies have debt to pay down, and both pay out the majority of free cash flow as dividends, so there is not a lot of wiggle room to substantially increase the dividend. However, both companies will likely remain committed to gradually increasing the dividend as additional growth in earnings and cash flow allows in the future.
Which is the better buy?
Although Kraft is slightly more expensive valuation-wise, I believe the higher P/E of Kraft Heinz is fully justified by the involvement of two long-term, shareholder-friendly owners like Berkshire Hathaway and 3G Capital having a voice on the future direction of the business. Plus, Kraft may have a slightly easier road to growth by introducing existing products to new markets, as opposed to Mondelez's path of revamping its products to fit consumer preference.
Therefore, I believe Kraft Heinz is the better buy.
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