Global Equities

Stock story: Kraft Heinz

A leaner consumer brands giant is looking to expand under the management of a Brazilian private-equity group.

3G Capital is a Brazilian-based private-equity firm with an almost-unparalleled record of improving businesses. The company is now a major shareholder of Kraft Heinz, which it manages. It is intent on making the world’s fifth-largest food and beverage group more efficient and even bigger.

3G’s owners first built their reputations for enhancing household-name businesses largely through improving and expanding brewing companies. They started with ownership of the Brazilian brewer Brahma in 1989 and by 2016 had formed the world’s biggest brewer in Anheuser-Busch InBev, which sells about one in three beers worldwide through brands such as Budweiser, Corona and Stella Artois.

In recent times, 3G expanded into the consumer-packaged-goods industry. In 2013, 3G joined with Berkshire Hathaway to buy HJ Heinz for US$23 billion, which it took private and ran more efficiently. Two years later came an even bigger creation: 3G and Berkshire Hathaway spent US$50 billion to purchase the listed Kraft Foods and merge it with the more-profitable Heinz. 3G owns 24% and Berkshire Hathaway 27% of the group that recorded US$26.5 billion in sales in 2016.

The core strategy of Kraft Heinz is to expand profit margins on its global brands while using the cash generated from these businesses to expand its presence in the consumer-packaged-goods sector, an industry ripe for consolidation.

This dual strategy – improving the profitability of existing lines while looking to expand through takeovers – means that Kraft Heinz is partially insulated from the angst plaguing consumer brands in the age of e-commerce and healthier lifestyles. If the Amazons of the world and better diets reduce the demand for competing brands, these companies may become more attractive takeover targets for Kraft Heinz. As such, Kraft Heinz appears to be entering a future where its products will become more profitable and where it will add more profitable lines. The company’s outlook, in short, is for higher earnings in coming years.

Even with 3G in charge, Kraft Heinz has challenges. One problem is that 3G’s reputation for using cost-cutting to improve businesses often stokes opposition to its bids, especially from the targets as was shown with Kraft Heinz’s failed bid for Unilever this year. The US$143 billion bid for the Anglo-Dutch food and personal care company was abandoned at launch because Unilever painted it as unfriendly.

Another challenge for Kraft Heinz is boosting sales when the consumer-packaged-goods industry’s revenue is susceptible to being substituted for private labels and to being overlooked by people who prefer natural and organic foods. Even considering these risks, though, the 3G-led drive to improve profitability and its expansion ambitions make Kraft Heinz an attractive risk-reward proposition for investors.

Long history

HJ Heinz’s history goes back to 1869 when Henry John Heinz started selling homegrown horseradish in Pennsylvania. By the time 3G took control of Heinz in 2013, the company was one of the world’s most recognised brands. But Heinz was struggling to grow sales.

Kraft’s history starts with the entangled story of three US entrepreneurs – James Kraft who started a cheese business in Chicago in 1903, Charles Post who founded a cereal company in Michigan in 1895, and Oscar Mayer who began a meat business in Detroit in 1883. By 2015, Kraft boasted more than 70 major consumer brands including Kool-Aid and Lifesavers and its products were found in nearly all US homes. It too faced challenges at the time.

The merger brought together a company that has eight brands, including Maxwell House, Philadelphia cheese and Planters nuts and the Kraft and Heinz brands, that earn more than US$1 billion in revenue each year.

3G boasts that it is a “strong meritocracy” in that employees must perform or they are out – others would describe the investment firm as a “ruthless meritocracy”. Whatever description is more apt, since assembling Kraft Heinz two years ago, 3G has reduced the company’s workforce by about 13,000 down to 42,000 workers and closed several plants including iconic ones. On a pro forma basis (assuming Kraft and Heinz were combined from the start of 2014), sales have declined by 9% but operating profits have increased 40% over the past two years, because profit margins have expanded by half to about 28%, well above industry averages of about 16%.

It’s this 3G ability to improve the businesses it takes control of plus the potential for takeovers within the consumer-packaged-goods industry that make Kraft Heinz a stock to watch.

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