Tuesday, 18 February 2020

Kraft-Heinz Continues to Fall

In May 2017 we looked at the proposed merger between Kraft-Heinz and Unilever, where we discussed the differing approaches to business taken by the two entities. Then, in May 2019, we looked at Kraft-Heinz again as it was under investigation by the SEC because of its accounting situation. More recently however, the company has continued to struggle and now it is the turn of the credit rating agencies to weigh-in and affect the situation for the struggling firm.

It was reported last week that, on the basis of Kraft-Heinz’s decision to maintain its dividend payouts to its shareholders despite an ever-growing debt burden, both S&P and Fitch would be downgrading the company to junk status i.e. non-investment grade. S&P cited the ‘unwillingness’ to change course on the dividend decision as a key factor in the downgrade decision, although the company has countered by declaring that ‘we believe it’s important to shareholders to maintain our dividend during this time of transformation’. Nevertheless, this ‘unwillingness’ as S&P see it, when combined with what S&P have declared has been ‘significant mismanagement’ over recent years, all adds up to a downgrade that could be massively impactful for a firm that needs to borrow, but who will now be barred from the investment-grade indices. For Fitch, it warned that the company may need to raise $9 billion from disposals to reduce its levels of leverage. Interestingly, Moody’s chose not to downgrade the company, instead placing it on a negative watch for a downgrade – I say interesting because Kraft-Heinz’s largest shareholder is also Moody’s’ largest shareholder; Warren Buffett’s Berkshire Hathaway.

If we look closer at Kraft-Heinz we can see that this turn of events should hardly be surprising and, in hindsight, why Unilever were so reluctant to get involved. Kraft-Heinz and its management has come in for plenty of criticism in recent years, and one of the main reasons is the approach taken by one of its constituent components – 3G Capital. 3G Capital, a Brazilian-based outfit, are renowned for creating profits via extensive and relentless cost-cutting strategies; the Kraft-Heinz deal was said to be based upon the fact that, at Heinz, there was very little else to cut and there was a need to bring in another high-cost business in order to keep the strategy going. This cost-cutting is continuing with Kraft-Heinz, but it is also being done with a challenging market place. Its products are increasingly falling out of favour with consumers, who are turning to fresher products than that offered by Kraft-Heinz. In response, Kraft-Heinz are embarking upon a strategy of reducing their selection of new products and also revitalising their current product base, in line with increased investment in its marketing campaigns for its increasingly outdated products. Yet, there is very little to suggest that the company will be on the mend anytime soon. The downgrades will have an effect and, if Moody’s decides to downgrade too, the situation will only get worse. Adding to the fact that it appears the company’s traditional position in the marketplace has been taken for granted whilst the market has moved on significantly, one can only imagine that it will take something special from the company’s management to arrest this slide – and if S&P’s declaration of mismanagement is true, then that seems to be a long-shot.

Keywords – Kraft-Heinz, junk, downgrade, credit ratings, @finregmatters

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