Kraft Heinz Is Winning Where It Counts, but Is That Enough?

Kraft Heinz (NASDAQ: KHC) owns some of the most iconic food brands in the world, including both of its namesakes. But the company's portfolio, as with many of its competitors, has become bloated and unwieldy. It is trying to do something about that. Will it be enough?

Kraft, meet Heinz

Both Kraft and Heinz were very large food companies before they merged, with the help of Warren Buffett's Berkshire Hathaway , to create Kraft Heinz in 2015. The goal back then was to bring together two cultures that had become soft over time and to get them back into shape with cost cutting and efficiency efforts. That didn't work out quite as well as planned, since you can't really cut your way to profits over the long term.

Image source: Getty Images.

When the reality of the situation became clear, management changed, and the company pivoted. The new goal is the same one that has been used by most of the major consumer products companies . It worked wonders for Procter & Gamble (NYSE: PG) , but only after a very public, and embarrassing, fight with activist investor Nelson Peltz.

Peltz is pushing the same idea today at Unilever , and it is starting to show some early success. Simply put, the plan is to focus on the best brands and get out from under everything else.

The problem is that this isn't an easy process, and it can take time to work through all of the details. Pushing Kraft and Heinz into one company probably made culling the weakest links a more difficult task in some ways because there are more brands to deal with as a result. But Kraft Heinz has laid out a vision that has a proven track record and is pushing forward.

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Kraft Heinz: 65%/11%/24%

At this point, around two-thirds of Kraft Heinz's sales come from brands it calls "accelerate." These are the fastest growing brands and the ones it wants to keep around. A little over 10% of revenue comes from brands it wants to "protect" and the rest, roughly a quarter of the company's sales, are brands it calls "balance."

Really, however, balance brands are likely on the chopping block. In fact, management would probably be happy to sell everything other than the accelerate brands. The list of sale candidates is pretty shocking, since it includes Oscar Mayer, Velveeta, and Kraft Singles, among others. These are iconic brands, but they are also old brands that have become stagnant over time.

To put a number on that, in the first quarter of 2024, balance brands and protect brands suffered organic sales declines of 4% and 5%, respectively. That's roughly a third of the top line that struggled, which is a very big number. To be fair, Kraft Heinz succeeded where it was focused, given that accelerate brands benefited from a 2% sales gain. But that wasn't enough to offset the weakness in the rest of the portfolio, with overall organic sales down 0.5%.

The second quarter wasn't nearly as good, though, with overall organic sales down 2.4%, the same number by which the accelerate brands declined. The only bright spot in the quarter was the modestly sized emerging-markets business, which helped soften the blow from weakness elsewhere in the portfolio but couldn't completely offset the overall downturn in the business.

That said, cost cutting allowed Kraft Heinz to improve its gross profit margin by 190 basis points in the first half of 2024 versus the year-earlier period. Although the quarterly results were mixed, management is executing in important focus areas, which led to a stock rally after second-quarter results were released.

From a big-picture perspective, though, there are really just three options here. One, stop the bleeding in balance and protect brands, but that would require more investment in brands that the company really doesn't want to spend much time on. Notably, the company's overall North American organic sales dropped 2.9% in the second quarter versus the accelerate brands, which were down 2.4%, so the non-core brands are still struggling.

Two, get the accelerate brands growing faster, which is a tall order in the highly competitive food space, where low-single-digit organic sales growth is generally considered a good showing. And the relatively difficult second quarter shows this is not going to be an easy task given the current market environment.

Or, three, start selling brands, which is the most likely outcome.

In fact, that's what Procter & Gamble did and what Unilever has been doing, though it is currently working to spin off its ice cream business because it hasn't been able to sell the division. Kraft Heinz could sell or spin off brands, but neither one is an easy process. Selling could require taking a low-ball bid, and spinoffs are time-consuming and costly, which would draw resources away from the accelerate brands.

In other words, Kraft Heinz remains a work in progress, and it could be a few years before it has managed through the process of right-sizing its portfolio. Investors, meanwhile, have taken a show-me approach here, pushing the stock price down materially since the merger of the two companies.

The opportunity with Kraft Heinz

This is a situation where being a small investor could actually work to your benefit, since you don't have to justify your holdings to anyone but yourself. That allows you to hold stocks that an investment committee would balk about, such as Kraft Heinz.

Although there is most certainly work to be done, management has proved that it can succeed in the areas where it focuses (accelerate, cost cutting). It just needs to get out from under the brands in the portfolio that it doesn't want anymore, a task that will take some time.

If you are willing to wait and monitor the progress being made, you can collect a generous 4.4% dividend yield. Don't expect dividend increases, but the payout ratio was a reasonable 55% or so in the first half of the year based on adjusted earnings.

In other words, the dividend looks pretty secure. And the average yield for a consumer staples company is only about 2.8%, so you are getting paid well for what looks like a reasonable risk now that Kraft Heinz is on the same track that has been successful for its peers. Income investors who think in decades and not days, and perhaps have a bit of a contrarian streak, might want to do a deep dive.

Reuben Gregg Brewer has positions in Procter & Gamble and Unilever. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends Kraft Heinz and Unilever. The Motley Fool has a disclosure policy .