In a 2015 deal backed by Warren Buffett's Berkshire Hathaway, Heinz bought Kraft to create Kraft Heinz (NASDAQ: KHC). It was a huge step in the consumer staples space, driven by the notion that cost savings could help these old industry giants become more profitable.
But investors focused on that have missed the equally -- if not more -- important changes that have taken shape on the balance sheet. Now, Kraft Heinz is looking to make some improvements on that front.
Building a giant
In 2013, Berkshire Hathaway paired up with 3G Capital to buy a controlling stake in iconic food maker Heinz. 3G Capital has a history of buying older companies with dominant brands and instituting cost cutting to improve profitability.
That was the playbook used at 3G Capital-controlled Anheuser-Busch InBev, which owns Budweiser and other dominant beer brands, and Restaurant Brands International, which controls Burger King and Tim Hortons. It's not a bad plan as companies often develop inefficiencies over time.
However, you can only cut costs so far before you either run out of costs to cut or begin to cut so deeply that you hurt the company's long-term prospects. Indeed, business growth is what leads to long-term success, not bleeding a company until it's dead.
That was one of the reasons why Heinz bought Kraft, because Heinz had started to run out of costs to cut. Essentially, it was easier to buy another company where the cost-cutting playbook could be run (again) than try to build a business by growing it from within.
The newly christened Kraft Heinz pushed down the cost-cutting path and, like Heinz, eventually ran out of runway. The coronavirus pandemic and subsequent spike in inflation didn't make life any easier for the company.
But now, management has shifted back toward investment in the business to foster innovation, which is a good call, with a key goal of "renovating" iconic brands.
Hiding in the background
That Kraft Heinz has gone from cost-cutting to investing in the business is great news, but there's another piece of news that is as important, if not more so. And that news is found on the balance sheet. If you look back at the company's long-term debt, it rocketed higher in 2015. That spike was associated with the merger.
For a number of years, Kraft Heinz's debt load was stuck at that elevated level, roughly between $30 billion and $35 billion. It wasn't until 2020 that the company got serious about its long-term debt. By 2023, the consumer staples giant had reduced its debt load by around $10 billion. From its recent peak, the company's debt-to-EBITDA ratio has declined from roughly 10 to just over 4 -- a huge improvement.
That represents a great deal of work and, though probably just a lucky coincidence, it proved timely given the current increase in interest rates. That's the first big benefit that Kraft Heinz will see from the effort to mend the balance sheet. While other companies are dealing with worrying increases in interest costs, Kraft Heinz is operating from a position of strength.
That leads to the second big benefit: The company has more flexibility to move, like the majority stake in Just Spices it bought in early 2022. Smaller bolt-on deals that are easier to fund can usually be grown fairly quickly as a giant like Kraft Heinz leverages its industry position to ramp up sales. Justifying such investments in growth when you are facing an over-encumbered balance sheet is hard to do. So, over the long term, getting the leverage position back to a manageable level has materially improved the growth outlook for Kraft Heinz.
Starting to get more appealing
After stumbling badly out of the gate (including a dividend cut), Kraft Heinz is starting to get its house in order. That includes a renewed focus on internal growth and building a balance sheet that can support continued acquisition-led growth. Kraft Heinz, offering a relatively attractive 4% dividend yield, might again be worth a closer look for long-term dividend investors. That said, the next big step will be a return to dividend growth.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends Kraft Heinz and Restaurant Brands International. The Motley Fool has a disclosure policy.