Has Kraft Heinz Finally Hit Rock Bottom?

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Kraft Heinz (NASDAQ: KHC) lost more than 30% of its value this year, with most of the drop occurring in February after it announced a $15.4 billion writedown on its Kraft and Oscar Meyer brands, disclosed an SEC probe regarding accounting issues, and slashed its dividend.

Even Warren Buffett, who oversaw the merger of Kraft Foods and Heinz in 2015, admitted that Berkshire Hathaway "overpaid" for its 27% stake in the packaged goods giant. Flickers of hope appeared when Kraft Heinz appointed a new CEO in April, but red flags remained.

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The company repeatedly delayed the filing of its 10-K report amid a rumored dispute with its auditor, then announced that it had to restate its annual reports for 2016 and 2017. Credit Suisse analysts warned that Kraft Heinz's 28% reduction of its headcount after its merger "may have played a role in the breakdown of internal controls."

However, Kraft Heinz recently concluded its internal investigation, filed its 10-K report, and stated that it would file its long-delayed first quarter 10-Q report on or before July 31. Kraft Heinz chairman Alex Behring stated the company was "returning to a path of normalization," and the stock rallied about 3% after the announcement on June 7. But does that mean Kraft Heinz's stock has finally hit rock bottom?

Reviewing Kraft Heinz's accounting headaches

Last October, the SEC launched a probe into Kraft Heinz's "accounting policies, procedures, and internal controls related to its procurement function." This included an audit of "agreements, side agreements, and changes or modifications to its agreements with its vendors."

Kraft's new 10-K filing reveals the extent of the mistakes made over the past four years. Its internal investigation found that it misstated its cost of products sold by $24 million in 2015, $35 million in 2016, $94 million in 2017, and $22 million in 2018.

Those misstatements represented less than 1% of its cost of products sold during all four years, and the company stated that the errors weren't "quantitatively material" to any of its past reports. However, Kraft said a restatement was necessary due to the number of "transactions, suppliers, and procurement employees" involved.

Kraft attributed the misstatements to the improper recording of supplier rebates, the classification of operating leases as capital leases, miscalculated customer incentive programs, various balance sheet errors, incorrectly recorded income taxes, and impairment losses recorded in the wrong periods.

Simply put, Kraft Heinz didn't properly check its work, and the problems snowballed from one period to the next. Its post-merger layoffs likely exacerbated the problem.

A baby step in an uphill battle

Kraft Heinz's filing of its 10-K report was a step in the right direction, but it still faces serious problems. To counter competition from healthier and private label brands, Kraft lowered prices to boost its organic sales -- but that desperate strategy crushed its margins.

Metric

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Organic sales

(0.6%)

(1.5%)

(0.4%)

2.6%

2.4%

Adjusted EBITDA margin

29.3%

28.5%

29.5%

25.3%

24.7%

Miguel Patricio, a former Anheuser-Busch InBev (NYSE: BUD) marketing chief who will become Kraft Heinz's new CEO on July 1, needs to reverse that trend, diversify Kraft Heinz's aging portfolio with new brands, and reduce its $31 billion in long-term debt.

That's a tough balancing act to pull off, but Patricio previously revived AB InBev's ailing Chinese business by instituting a "premiumization" strategy for its flagship Budweiser brand and expanding local brands like Harbin. Kraft also recently elected João Castro-Neves, another former AB InBev exec, to join its board.

Is Kraft Heinz too cheap to ignore?

Kraft Heinz trades at just 10 times forward earnings, and it still pays a 4.8% forward yield after its big dividend cut. That low valuation and high yield should set a floor under the stock, and the regulatory headwinds should fade with the filing of its 10-K report.

But that doesn't necessarily mean that Kraft Heinz is a worthy investment. Its rival General Mills (NYSE: GIS) trades at 16 times forward earnings and pays a lower forward yield of 4%, but its margins are expanding and it's diversifying aggressively into adjacent markets like premium pet food.

Therefore, Kraft Heinz's stock might be bottoming out, but there aren't any near-term catalysts to help the stock recover. For now I'd watch Miguel Patricio's performance over the next few quarters to see if he can turn this ship around.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Anheuser-Busch InBev NV. The Motley Fool has a disclosure policy.