Kraft Heinz shares have been steadily declining since the company reported its fourth-quarter sales in mid-February. The report showed sales fell five percent and failed to hit Wall Street’s forecasts. Although its earnings surpassed what analysts had estimated, its shares still fell eight percent.
The drop is a reflection of investors’ worries that have been building in recent years about the future of the ketchup and macaroni giant. During the earnings conference call, the billion-dollar company failed to assuage fears by providing a formal 2020 earnings guidance, as it had done in previous years, and a turnaround plan to jolt the company out of the sales slump it has been experiencing.
Instead, Kraft Heinz revealed another $666 million impairment. An impairment decreases the company’s goodwill account on its balance sheet. Goodwill is an intangible asset that isn’t easily quantified, such as a company’s brand name, strong customer relations, and proprietary technologies. During an acquisition, Goodwill is recorded for the cost paid over the acquisition’s book value for its intangible asset. Companies periodically review the intangible asset’s value, and when the current market value is below the intangible asset’s purchase price, they are required to write-down the goodwill asset.
The $666 million goodwill write-off was small change compared to Kraft Heinz shocking $15.4 billion impairment charge in February 2019, and $1.2 billion goodwill write-off later in the year. The impairment expense shows as a loss on the income statement and reduces the net income for the year. As a result, the company’s stock price and earnings per share took a hit as well.
But the dip in shares is part of a consistent downward trend in Kraft Heinz’s recent stock history. Stock values have slid down so that today, it’s 22 percent lower than its highest price last January, and a whopping 74 percent less than its peak price in the past three years. In February 2017, Kraft Heinz saw its stock reach $96.65. Today, it stands at $24.77.
Where did Kraft Heinz go wrong, and can it still get it right?
Where Kraft Heinz Went Wrong
Confusing Long-Term Growth With Short-Term Cost-Cutting
In 2015, Kraft and Heinz joined together through a $63 billion merger with Warren Buffett’s Berkshire Hathaway and 3G Capital, a private equity firm overseen by Jorge Paulo Lemann, Brazil’s richest man. 3G Capital had bought Kraft only two years earlier in 2013; it was right on schedule for another acquisition. 3G Capital’s game plan is always the same. Buy control of a company, usually one in the food industry, drastically cuts costs through zero-based budgeting, acquire another company in about two-years time, repeat.
Zero-based budgeting requires each employee to justify every expense, every day—even if that’s themselves. Once 3G Capital swoops in, costs that don’t make the cut are eliminated. When 3G Capital purchased Kraft in 2013, it immediately took out the office refrigerators filled with free Kraft products, did away with corporate planes, and only gave out coach tickets to employees when flying, including the CEO.
Eventually, Kraft reached a point where it couldn’t cut costs anymore to increase its profits. To continue being lucrative, it needed to take on another high-cost company. Hence the deal between Kraft and Heinz. Two years after the merger, Kraft Heinz had cut its workforce by 20 percent—including several of its top managers, and slashed its overhead expenses by a staggering 40 percent.
When the company again reached the point it could no longer eliminate any significant expenses, it maintained true to its playbook; Kraft Heinz sought to acquire another high-cost business to continue its cost-cutting escapade. Unilever was its target in 2017, but things went awry when Unilever firmly objected to the mega-merger. Rather than wage war, Buffett and Lemann decided to withdraw their offer.
Now five years without an acquisition, Kraft Heinz—and its investors—can see how its singular focus on trimming the fat may have sacrificed the company more than superfluous expenses.
By shifting all its attention short-term gains, no thought was given to what would sustain the company in the future, namely innovation and adapting to new market demands. Even if long-term value creation was ever addressed, these endeavors require time, money, and research whose costs cannot be immediately justified in a zero-based budget.
Innovation breakthroughs also often come after a string of failed projects. But with employees having to justify their salaries daily, any failures would likely not have been met with a sympathetic eye from upper management.
Another acquisition now for Kraft Heinz to save its skin seems unlikely. Finding a company willing to sell for the right price is challenging, overall stock prices are rising, and other mega-companies are taking a page from 3G Capital’s strategy book and buying other companies before 3G Capital can get to them.
Missing Key Health-Food Acquisition Opportunities
Focusing all its efforts on cost-cutting blinded the company to changing market tastes. Millennial shoppers want healthier food choices, private labels, and fresh, local products. Offerings that were once the heartbeat of Kraft Heinz, like Kool-Aid, Velveeta, and Miracle Whip, no longer whet customers’ appetites, and sales have gone flat.
In contrast, only a few hours before Kraft Heinz’s announcement of its $15 billion impairment in 2019, Danone’s chairman and chief executive officer, Emmanual Faber, gave a conference in which he showed his audience how the company breathed new life into Danone’s Activia yogurt brand.
Danone’s global relaunch of Activia in 2016 was a failure and accelerated its year-over-year single-digit sales declines into double digits. In 2017, the company did another Activia relaunch, but this time they changed their product to have simple ingredients, local variations, and sensibly-sized packs.
As part of the initiative, Danone moved away from its previous 24- and 16-count packs into ones that consumers liked better. They also added new flavors and varieties to cater to local tastes and make its product convenient for everyone. In Mexico, for instance, Danone added a plant-based variety of Activia. Activia consumers could also now get their probiotics dosage in a mix-in, cup, drinkable, or shot variations.
Since its turnaround, Danone’s Activia performance has given it positive quarterly returns in 2019, and the company expects a two to four percent sales growth in 2020.
Other big-food companies also noticed the trend of cleaner, organic, and less processed foods and jumped at the possibility of entering healthier markets.
Kellogg, with its carb- and sugar-laden menu of cereals, Pop-Tarts, and Pringles potato chips, made a move toward a healthier portfolio by scooping up RXBAR in 2017 for $600 million. General Mills acquired Annie’s in 2014 for $820 million and Blue Buffalo pet food in 2018 for $8 billion. Hershey bought Amplify Snack Brands, maker of SkinnyPop, in 2017 and B&G Foods, maker of Pirate’s Booty, in 2018. ConAgra also snatched up Pinnacle, owner of brands like Smart Balance and Udi’s gluten-free foods.
Kraft made a move to acquire Heinz in 2015 and Unilever in 2017. Still, its focus was on mega-mergers for higher cost-cutting opportunities rather than diversifying its portfolio with healthier, in-demand products.
The company did make small moves, such as purchasing Ethical Bean in 2019, a small Canadian coffee brand making an estimated $5 million to $10 million per year, according to the British Columbia government website. In 2018, Kraft Heinz also purchased Primal Kitchen for $200 million and launched SpringBoard, an incubator program designed to grow and scale U.S. food and beverage brands disrupting the industry. Kraft Heinz also partnered with Oprah in 2017 to create a new line called, “O! That’s Good!,” and bring a healthy twist to classic comfort foods.
But Kraft Heinz’s invested significantly less in its acquisitions of health-companies than its competitors, and none of the additions have done much to bolster the company’s sales. If Kraft Heinz had hoped it could get serious now and grab one of the remaining health-food companies for a steal, it might have waited too long. Prices for these types of companies have increased, and merging with them is no longer a feasible option for the company in the near future.
Losing Relevance With a New Generation of Buyers
Kraft Heinz still has many beloved legacy brands it can count on, but its products seem tired and outdated when compared to the fresh, local foods consumers are reaching for. A supermarket’s center aisles, stacked with boxes and cans of prepackaged goods, used to be seen as its lifeline. Increasingly, those same center aisles are becoming a dead-zone as customers skip them for products in peripheral sections where more natural and less processed options exist.
Kraft Heinz’s recently started taking small steps to make its traditional products more enticing. Recently, it launched a ketchup with no corn syrup and 25 percent less sugar than its original. The bottled product also included a nutritional boost, thanks to its added blend of vegetables like carrots and butternut squash. But it’s non-core brands like Maxwell House, Breakstone sour cream and cottage cheese, and Plasmon baby food are still limping along.
Besides offering more products that today’s customers want, Kraft Heinz would do good in meeting its customer needs to attract current and future generations of shoppers. While much of the nation is requesting good-for-you food choices, many millennials also want them to be convenient. Meal-kit providers like Blue Apron and Sun Basket have exploded onto the scene in recent years, as have food-ordering platforms like GrubHub and UberEats.
To capture Millennials, Kraft should consider convenience. Millennials might not reach for boxed macaroni and cheese, mayonnaise, and canned tuna anymore, but they just might go for a tuna pasta salad with organically-grown veggies.
What Kraft Heinz May Be Getting Right
Technological Investments in A.I. Platforms
To add more value to the brand for consumers, Kraft Heinz acquired Evolv Group in 2018, a digital firm. In mid-2019, the company launched an AI-powered meal planning app called “Meal Hero” that links to Instacart to make weekday meals and grocery shopping a more efficient process. The app is a win-win with customers and Kraft Heinz alike. Users can download the app for free, quickly create tailored menus, and buy the ingredients with ease. In return, Kraft Heinz gets exclusive insights into its users’ dietary and shopping behaviors and preferences.
The app is still in its early stages, and monetary returns or commercialization opportunities won’t be immediate. However, it could prove to be a lucrative long-term strategy that jives well with the company’s founding goal of mining data to understand its customers better and provide innovative products in line with their findings.
If anything, the app is a subtle shift away from the company’s myopic business strategies. The initiative could also push other divisions to move away from the cost-cutting mentality that has been so prevalent with Kraft Heinz in recent years, to one that thinks more creatively and returns the customer to the center of its business model.
Pruning Weak Performers for Stronger Core Sales
In the February earnings call, Kraft Heinz’s new CEO, Miguel Patricio, who stepped in mid last year, announced that “2018 was the first year our U.S. zone reduced its total SKU count since the Kraft-Heinz merger. In 2020, we will accelerate the rate of reduction to bring us back to below 2016 levels.” Patricio also stated, “We will be redirecting dollars disproportionately toward support of our flagship brands. We will also strengthen brand support with more total marketing dollars…and by better prioritizing our spending according to portfolio roles.”
As a result, Kraft Heinz’s marketing agencies will reduce from 36 to 19. Still, the company will increase its working media budget this year by 30 percent, “with even greater increases behind the brands that are the biggest drivers of our profitability.”
Though there will be a 50 percent budget cut for product innovations—reducing the number of new products in 2020 to half of 2019’s, the decrease is still in line with the CEO’s statement of giving more attention to flagship products. “Because we have less innovation, we are concentrating more on the bigger brands that have more momentum, better margin, and that we have to grow.”
Considering Kraft Heinz’s stagnant growth, cutting loose poor performers to have more resources available for its core products and brands may be what the company needs to regain its strength. But the move calls in to question what will happen to its niche brands like Ethical Bean and Primal Kitchen, and what the future holds for its Springboard platform and all the employees who work within those companies.
Kraft Heinz stocks have plummeted in recent years. Kraft Heinz’s excessive cost-cutting and failure to innovate or change with market trends are held as reasons why the company is losing its value and place in American homes.
Kraft Heinz’s failure to acquire Unilever in 2017 unveiled the glaring problems behind 3G Capital’s one-trick bag of buying mega-companies, and then drastically reducing expenses to turn profits and give the impression of strong company growth and financial health. But investors are no longer dazzled by 3G Capital’s smoke-and-mirror tactics and want answers as to how the company plans to move forward in 2020 and beyond.
To gain a better sense of its customers’ needs, Kraft Heinz launched its meal planning app, Meal Hero, in 2019. Though it may provide valuable insights about customers as its userbase grows, it’s not the needle-mover Kraft Heinz needs to regain its footing.
New CEO Miguel Patricio is still tightening the company’s expenses for 2020 as it funnels savings into strong performing brands and products to revamp them and give them more visibility. The move may sacrifice its smaller niche brands like Ethical Bean, but revitalizing its iconic brands for a new generation of shoppers may be enough to move its products from store shelves into consumer carts.