Kraft Heinz exposes Corporate America's debt problem
Posted February 25, 2019 3:12 p.m. EST
CNN — The Kraft Heinz food empire has a debt problem.
Heinz took on debt when the ketchup giant was taken private in 2013 by 3G Capital for $28 billion. Financing was also a key ingredient that made the marriage of Kraft and Heinz possible in 2015.
The Warren Buffett-backed food giant's serious missteps have brought its bloated balance sheet into sharp focus.
Last week, Kraft Heinz posted a massive loss of $12.6 billion and warned that 2019 profits will tumble. Its stock price plummeted 27% on Friday.
Kraft Heinz, the owner of Oscar Mayer, Velveeta and Planters nuts, is now scrambling to raise cash that can be used to pay down its nearly $31 billion of long-term debt.
The food giant slashed its dividend by 36% and announced plans to sell off brands, reportedly including the Maxwell House coffee business.
"Its balance sheet has ballooned," JPMorgan Chase analyst Ken Goldman wrote in a report late last week.
Goldman noted that Kraft Heinz's profits are "flat," revenue has "shrunk" and the balance sheet is "levered."
"This is not an ideal progression of financial metrics," Goldman wrote.
And that's not to mention the SEC investigation into Kraft Heinz's books that the company disclosed.
Record debt levels in Corporate America
The Kraft Heinz debt trouble serves as another reminder of the large amounts of debt that Corporate America has taken on during a decade of extremely low interest rates.
General Electric, another storied American company, is similarly racing to dismantle itself to raise gobs of cash that can be used to shore up its balance sheet. And GE, which long boasted of a stable dividend, slashed its cherished payout to a penny.
Nonfinancial corporate debt to GDP has never been higher going back to records that began in 1947, according to the Office of Financial Research, a Treasury Department bureau created after the 2008 financial crisis.
Kraft Heinz is sitting on $30.9 billion of long-term debt, up from $28.3 billion a year ago. That amounts to a sizable leverage multiple of 4.4 times the company's 2018 adjusted earnings.
The balance sheet could come under even more strain this year. Kraft Heinz projected that 2019 earnings will fall sharply to about $6.4 billion. That would lift its leverage level to the uncomfortably high multiple of 4.8.
Deep cost cutting comes back to haunt Kraft Heinz
The Kraft Heinz disaster demonstrates how piling on tons of debt can be problematic when a management team's strategy misfires.
Years of cutting costs to the bone have finally come back to haunt Kraft Heinz.
The company announced last week it's writing down the value of the Kraft and Oscar Mayer brands by $15 billion.
"The overwhelming emphasis on taking costs out and improving margins has come at the expense of the company's long-term health," said Erin Lash, a Morningstar analyst.
Lash said that "excessive leverage" has long been a problem at Kraft Heinz.
She noted that Heinz's leverage shot up to 4.8 times earnings at the end of 2014 following the takeover by 3G Capital.
Kraft, on the other hand, had a healthy leverage ratio of just 2.8 times projected earnings at that point. The companies merged the next year.
Speeding up balance sheet clean up
The good news is that Kraft Heinz is taking significant steps to address its balance sheet.
David Knopf, Kraft Heinz's chief financial officer, told analysts last week that the company will "accelerate our deleveraging." That includes dedicating the proceeds from the company's sale of its India beverage and Canadian natural cheese businesses to reduce debt.
And Kraft Heinz said it plans to do the same with the money raised from additional asset sales the company is currently considering.
The dividend cut will save Kraft Heinz more than $1 billion a year — cash that can also be used to shore up the balance sheet.
However, Stifel analyst Christopher Growe told clients that this will "do little" to reduce the company's lofty leverage ratio.
Kraft Heinz said its goal is to slash the leverage ratio to just three times earnings.
JPMorgan's Goldman warned that Kraft Heinz won't generate enough cash to hit that target for "many years."
Even assuming Kraft Heinz pays down nearly $3 billion of debt over the next two years, the company's leverage would only come down to 4.1 times earnings by the end of 2020, JPMorgan said.
That could leave Kraft Heinz with little cash to invest in its faltering brands.
Credit rating downgrade?
Last week, S&P Global Ratings put Kraft Heinz on notice for a downgrade over the next two years. The company's BBB credit rating is just two notches above junk.
Kraft Heinz would be downgraded "if the business continues to falter," if its credit ratios fail to improve or if the ongoing SEC investigation uncovers further problems, S&P said.
"Clearly, they have to de-lever. There's no doubt about that," S&P analyst Jerry Phelan told CNN Business.
While Kraft Heinz execs promised to clean up the balance sheet, their comments also suggest the debt problem could come back.
CEO Bernardo Hees said the strategy to deleverage faster is aimed at giving the company "more firepower" to position it for "future consolidation."
In other words, Kraft Heinz wants to quickly lever back up to pay for more acquisitions. Perhaps it didn't learn the painful lesson here about the pitfalls of excess debt.