Samir Mehta

Senior Fund Manager, JOHCM

In a pickle: Kraft Heinz

Pickle: any brine, vinegar or spicy solution used to marinate food; synonym – predicament: a condition or situation that is difficult, unpleasant, embarrassing or comical.

 

The annual results of Kraft Heinz and the commentary on what has happened to its business in the past couple of years has several lessons for those who invest in quality businesses. 

With the imprimatur of Mr Buffet, the deal to combine Heinz and Kraft was a landmark transaction. An almost ruthless approach to cutting costs by the new owners was the new mantra for managing businesses with moats and steady revenues. In February 2017, it even made a hostile bid to acquire Unilever; today Kraft’s market cap is less than Hindustan Lever, its Indian subsidiary.

So what went wrong?

– To start with the easy part: leverage. It is one of the defining moves employed by private equity firms – financial engineering (in the garb of attaining the ‘right’ debt:equity mix). This led a stable business to take on significantly more debt. In itself that might not be wrong, but when a business faces challenging conditions, management teams face mounting pressure to remain within debt covenants to the detriment of investments in the future.

– Second, was the zero-based budgeting approach to cost cutting. Popular at one time amongst business consultants, it drove management by the mantra of ‘why should you spend?’ Perhaps that question is justifiable for administrative costs, but if applied to all costs this might defeat the purpose of managing and rejuvenating a steady cash-generative business.

– Finally, disruption in business conditions. The world over, retail chains were the first to feel the impact of online disruption; food and staple brands are increasingly feeling the effects now. The changing tastes of millennials, niche new brands that can scale thanks to influencer endorsement marketing strategies and help from online platforms for nationwide delivery are challenging incumbents.

It is critically important to reinvest continually into the business to maintain existing brands and create new ones. That ultimately is the crux of the ‘moat’ of quality branded businesses. In Kraft’s case, perhaps the high debt and focus on cost cutting left management with little room to focus on what should have been the core capital allocation decision.

 

In next week’s edition Samir compares the Kraft Heinz experience with India’s paint industry, to show the importance of balancing cost cutting initiatives and investing for the future. 

 

Read more about the Pendal Asian Share Fund

 

Subscribe