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Kraft’s Fall From Grace

Kraft singles packaging detail.
photo by Mike Mozart

There was a time, not long ago, when the idea that Americans would keep eating Kraft Singles and Heinz ketchup was the epitome of a safe bet. Today, the beleaguered Kraft Heinz Co. illustrates the valuable investing principle that no bet stays safe forever.

In late February, Kraft Heinz stock plummeted due to the surprise announcement of a fourth-quarter loss of $12.6 billion, which included a $15.4 billion write-down of some of its major brands. The company also told investors that it faces an accounting investigation by the Securities and Exchange Commission and that it would be cutting its dividend by 36 percent. In response, shares fell as much as 28 percent in a single day. The company’s stock value is down about 60 percent from its peak two years ago.

Kraft Heinz owns some of the biggest brands in the packaged foods industry: Oscar Mayer, Jell-O, Philadelphia cream cheese, Maxwell House coffee and many others. What went wrong?

Part of the problem has been an overall shift in Americans’ food-buying habits. Consumers are increasingly concerned with buying fresher foods, or at least processed foods with fewer and more natural ingredients. They are, on the whole, not terribly loyal to brands that they grew up eating; today’s shoppers may be nostalgic for Kraft Macaroni & Cheese, but they’re still more likely to reach for Annie’s Vegan Shell Pasta and Creamy Sauce – or, perhaps, a block of cheddar and a package of whole-wheat macaroni so they can DIY.

The way Americans shop is also changing. Many consumers buy groceries at places other than traditional grocery stores, including online. Amazon now owns Whole Foods and also reportedly plans to open additional grocery stores aimed at driving Prime membership. Customers at big discount retailers, such as Costco, also increasingly favor cheaper, store-brand (or “private label”) versions of processed food staples to the extent that they still buy them at all. From the end of 2016 to the end of 2018, Kraft Heinz’s revenues fell by $229 million, or about 1 percent.

The SEC investigation into the company’s accounting practices does not necessarily indicate that Kraft Heinz has done anything wrong, or even that its accounting is likely to change substantially in the future, but the probe is yet another blow to the company’s image at a time that it is badly positioned to roll with the punches. David Knopf, the company’s chief financial officer, told investors that the SEC subpoena led to an internal investigation, which discovered $25 million in costs that should have been recorded in earlier periods, rather than the fourth quarter. The accounting problem may not be material, but investors don’t expect this sort of unpleasant surprise from a large, established company like Kraft Heinz.

While some of the obstacles facing Kraft Heinz are industry-wide challenges to processed food producers, some are a direct result of misguided management. In the past few years, Kraft Heinz’s approach has focused on significantly cutting costs. Kraft and Heinz merged in 2015, and Berkshire Hathaway Inc. remains its biggest shareholder; however, its second-largest shareholder, Brazilian private equity firm 3G Capital, is responsible for managing the company. 3G has a reputation for seeking to dramatically lower costs at the companies it owns, and Kraft Heinz has been no exception. Under 3G’s leadership, the company has focused on making factories more efficient and significantly reducing headcount. It also has scaled back in-store promotions and discounts, weakening its relationship with supermarkets and other retailers.

A year ago, Kraft Heinz committed to refreshing its existing brands and introducing new products. But to the extent the company has done this, it clearly has not gone far enough. For example, the introduction of Mayochup (a premixed mayonnaise-ketchup hybrid) failed to win over large numbers of potential customers. The company’s plan to introduce Mayocue and Mayomust isn’t likely to turn the tide either.

On the other hand, it seems as if leaders at the company are committed to the idea that they simply didn’t cut costs sharply enough. Kraft’s chief executive, Bernardo Hees, said on an investor call that earnings fell short because the company didn’t deliver sufficient cost savings, according to The New York Times.

When an analyst pressed him on whether the extreme cost-cutting measures may have been detrimental to Kraft Heinz, Hees said, “We still believe strongly that our model is working and has a lot of potential for the future.”

It is too soon to say that Kraft Heinz cannot bounce back. Yet its leaders’ continued evident commitment to slashing costs gives investors little reason to be optimistic.

Whatever comes next for Kraft Heinz, the company serves as a useful reminder to investors. Even in the safest company you can imagine, circumstances can take unexpected turns. Companies can face changing tastes and culture trends, like processed food makers. They can face a disastrous product malfunction, like Samsung or – more tragically – Boeing. New technology, human error or bad marketing choices can all abruptly change a company’s fortunes.

Kraft Heinz proves that while some companies are riskier than others, there is no such thing as a permanently “safe” investment. Investors should bear in mind that nothing lasts forever – not even ketchup and American cheese.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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