Kraft Heinz’s high dividend is just too good to be true

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Kraft Heinz (NASDAQ: KHC) has executed a surprising turnaround in the past year. As of early 2020, the packaged food giant was still grappling with sluggish sales, sinking margins, large write-downs, a cut in dividends and an SEC investigation into its accounting policies and delayed filings.

However, the pandemic has prompted consumers to stock up on Kraft Heinz packaged foods, and its organic sales have started to rise again. As a result, her stock has risen by over 40% in the past 12 months, and she still pays a high term dividend yield of 3.7% after reducing her payout by 36% in 2019.

Image source: Getty Images.

Kraft Heinz stock also looks cheap with 16 times expected earnings, which could make it an attractive investment as the the market is spinning from growth to value stocks. But before investors assume Kraft is undervalued dividend shares, they should also recognize its biggest problems.

Its payout rate is still high

Kraft Heinz dividend payments consumed more than 100% of its GAAP benefit in 2019 and 2020. On a non-GAAP basis, which excludes its divestments, write-downs, write-downs, stock premiums and other “one-off” expenses, this payout ratio remained below 100%.

Period

FY 2019

FY 2020

Q1 2021

Dividends per share

$ 1.60

$ 1.60

$ 0.40

EPS (GAAP)

$ 1.58

$ 0.29

$ 0.46

BPA (non-GAAP)

$ 2.85

$ 2.88

$ 0.72

Data source: Kraft Heinz.

The Bulls might argue that Kraft’s earnings-based payout ratio will stabilize in the long run, especially if we only look at its non-GAAP earnings, but these expenses will always reduce its cash position.

He should reduce his debt first

Kraft Free Cash Flow (FCF) jumped 56% to $ 4.33 billion in fiscal 2020, as its organic sales grew 6.5% throughout the crisis.

Its FCF jumped another 619% year-over-year to $ 583 million in the first quarter of 2021, thanks to an easy comparison to the initial impact of the pandemic a year earlier, as its organic sales increased 2.5%.

Kraft has only spent about 41% of its FCF on its dividend in the past 12 months, and this low payment of dividends in cash ratio indicates that its payments are still viable. Kraft has gradually reduced its long-term debt over the past two years, but its net debtAdjusted EBITDA the ratio remains very high.

Period

FY 2019

FY 2020

Long-term debt

$ 28.22 billion

$ 28.07 billion

Net debt to adjusted EBITDA

4.3

3.7

Data source: Kraft Heinz.

Kraft has enough cash on hand to cover the current portion of its long-term debt ($ 126 million), but it arguably makes more sense to improve its balance sheet before paying big dividends.

It should invest in new products and marketing campaigns

Kraft struggled for many years because it focused on reducing costs instead of investing in new products, buying higher growth brands and launching new marketing campaigns. Today, it still sticks to a “zero-based” budgeting strategy, which cuts the costs of its existing operations to free up more cash.

This frugal approach could support its operating margins, especially as competition and inflation weigh on its gross margins, but it could also prevent it from investing in new products and marketing campaigns to remain competitive.

After the pandemic ends, shoppers are likely to stock up on less groceries and become more selective in their food purchases again. Competition from healthier brands and private labels will exacerbate this pressure. These trends already hurt Kraft Heinz before the pandemic and will likely return after the crisis ends. Instead of paying almost $ 2 billion in dividends each year, I think Kraft Heinz should cut those payments and reinvest more in its business.

Kraft Heinz still has a lot to prove

Kraft Heinz CEO Miguel Patricio, who took over the management two years ago, appears to be stabilizing the company. But much of its recent growth should be attributed to the pandemic rather than significant improvements in its core business, and analysts still expect its annual revenues to decline over the next two years.

Kraft Heinz may not cut its dividend anytime soon, but investors might be better off sticking with General Mills (NYSE: SIG), which make fewer faces headwinds in the short term, pays a forward yield of 3.3% and trades at just 17 times forward earnings. Coca Cola (NYSE: KO), a King of dividends which trades at 23 times forward earnings, pays a 3% return and has much stronger brands. Both stocks have significantly outperformed Kraft Heinz over the past five years. Based on all of these facts, I think Kraft Heinz stock is cheap for obvious reasons, and its high dividend is just too good to be true.

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Lion sun has no position in any of the listed securities. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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