Kraft Heinz (KHC) Cost Cutting Drives Q2 Earnings, Sales Soft

We issued an updated research report on The Kraft Heinz Company (NASDAQ:KHC) on Aug 10, 2016.

On Aug 4, Kraft Heinz reported mixed second-quarter 2016 results.

The packaged food company beat the Zacks Consensus Estimate for earnings but missed the same for sales. Adjusted earnings per share of 85 cents surged 39.3% year over year as cost savings mitigated weak sales trends and a higher tax rate. Organic sales declined 0.5% in the quarter due to lower volume/mix. Volume/mix declined 2.1% in the quarter in comparison to a 0.8% rise in the previous quarter as improvement in the Rest of World was neutralized primarily by declines in the U.S. and Canada. Europe volumes were almost flat in the quarter.

Kraft Heinz is seeing top-line weakness over the past several quarters. Soft spending by U.S. shoppers along with rapid changes in consumer preferences and behaviour are hurting the company’s categories.

Kraft Heinz’ categories have been sluggish due to soft global retail and consumer demand. Consumption trends in a number of the company’s key categories like ready-to-drink beverages, frozen meals and salad dressings remain challenged.

Though organic sales improved slightly in first-half 2016, management noted that consumption trends in a number of categories remained weak in an increasingly competitive retail environment. Organic sales declined in two of the biggest segments in first-half 2016 – 0.9% in the U.S. and 3% in the Europe segment. Management warned that consumer trends are likely to remain challenged in both North America and Europe in the second half of the year.

Though the company’s sales have been relatively soft, cost savings have led to better margins, mainly in the developed markets of the U.S. and Europe. While organic sales rose only 0.3% in first-half 2016, adjusted EBITDA rose over 25% on a constant currency basis.

This Zacks Rank #2 (Buy) company has implemented many cost-saving initiatives including the integration of Kraft Foods and Heinz. The company plans to save $1.5 billion in annual costs by the end of 2017, mainly through work-force reductions, factory closures and consolidations. The company generated about $535 million of cost savings in first-half 2016.

Other productivity improvement initiatives include programs such as zero-based budgeting; modernization and capability building within the manufacturing footprint along with building a performance driven culture in the company.

A portion of its savings is being re-invested in the business for innovation, brand building and marketing to stimulate top-line growth. The company is also working for whitespace expansion of Kraft and Heinz brands in both food services as well as international channels.

With growing consumer demand for organic and more nutritional food, Kraft Heinz launched organic Capri-Sun juices and Mac & Cheese dinner (under its Cracker Barrel brand) without artificial ingredients in 2016. It also renovated the Kool-Aid Jammers product with fewer calories and no preservatives and added a new line of Classico Riserva branded premium pasta sauces made with no artificial ingredients or added sugar. Further, frozen meals with enhanced nutrition is in the pipeline for launch this year.

Moreover, in 2016, the company will continue to focus on shifting advertising spend from non-working (like production costs, advertising agency costs) to working media (digital, print advertisements) and eliminate inefficient trade promotion spending. In fact, management has plans in place to boost overall marketing spending in markets like the U.S. and Europe in 2016.

These product innovation efforts and improved marketing spend can lead to better sales trends, going forward.

Stocks to Consider

Other well-ranked food stocks are Omega Protein Corporation (NYSE:OME) , Ingredion Incorporated (NYSE:INGR) and Treehouse Foods, Inc. (NYSE:THS) . While Omega Protein and Ingredion Incorporated sport a Zacks Rank #1 (Strong Buy), Treehouse Foods holds a Zacks Rank #2.