3 Reasons to Avoid KHC and 1 Stock to Buy Instead

Over the past six months, Kraft Heinz’s shares (currently trading at $24.96) have posted a disappointing 6.8% loss, well below the S&P 500’s 14.1% gain. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.

Is there a buying opportunity in Kraft Heinz, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free for active Edge members.

Why Do We Think Kraft Heinz Will Underperform?

Even with the cheaper entry price, we're cautious about Kraft Heinz. Here are three reasons why KHC doesn't excite us and a stock we'd rather own.

1. Demand Slipping as Sales Volumes Decline

Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful staples business as there’s a ceiling to what consumers will pay for everyday goods; they can always trade down to non-branded products if the branded versions are too expensive.

Kraft Heinz’s average quarterly sales volumes have shrunk by 3.8% over the last two years. This decrease isn’t ideal because the quantity demanded for consumer staples products is typically stable.

2. Shrinking Operating Margin

Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Analyzing the trend in its profitability, Kraft Heinz’s operating margin decreased by 34.6 percentage points over the last year. Kraft Heinz’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 23%.

3. Previous Growth Initiatives Haven’t Impressed

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

Kraft Heinz historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 1.2%, lower than the typical cost of capital (how much it costs to raise money) for consumer staples companies.

Final Judgment

Kraft Heinz doesn’t pass our quality test. Following the recent decline, the stock trades at 10.2× forward P/E (or $24.96 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are better stocks to buy right now. We’d recommend looking at one of our top digital advertising picks.

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