Chart of the Day – Kraft Heinz (KHC) Cutting the Mustard?

by Dan February 28, 2017 1:09 pm • Chart of the Day

It’s been a weird couple of weeks for shares of Kraft Heinz (KHC). The stock closed down 4.2% on Feb 16th, the day following fiscal Q4 results that on the surface appeared good, but as Barron’s noted:

When 3G and Warren Buffett’s Berkshire Hathaway (BRK.B) got together to merge Kraft with Heinz to form Kraft Heinz (KHC), they argued that they could cut expenses to create a more efficient business. But if today’s earnings–which appeared, at least on the surface, to be pretty good–demonstrated anything, it’s that Kraft Heinz might be running out of synergies to juice profitability.

It appears that Warren Buffett’s Berkshire Hathaway and 3G Capital (the two investors behind the joint bid in 2013 for HJ Heinz and then the 2015 merger of Heinz and Kraft) who together own 50% of the shares outstanding were having none of it, and word leaked the next day that the company was pursuing a friendly $143 billion bid for Unilever, sending the stock to new all time highs up 10%!

KHC 1yr chart from Bloomberg

Two days later KHC pulled the offer, and the stock quickly retraced to its pre-earnings gap level ($90-$91). It also happens to be fairly important technical resistance level dating back to last Summer.

Which brings me back to the first point from Barron’s, analysts expect KHC to grow earnings 14% in 2017, on a 1% sales increase, it appears that the with synergies from the prior deal running out, they were in search of new combinations. KHC trades nearly 24x expected 2017 eps, and 27x trailing, which is rich to an already expensive group with Mondelez (MDLZ) trading 21x and Coca-Cola (KO) trading 22x, Campbell’s (CPB) & General Mills (GIS) trading 19x and Unilever (UN) trading 21x.

Assuming we can take Mr. Buffett at his word from yesterday in his interview with CNBC,

“There isn’t any back-up deal. That was the only one that certainly I seriously thought about that made sense,”

… then the stock might be fully valued for the time being and be susceptible to a pullback towards near term support at $85. But the stock’s ability to hold above prior resistance is certainly impressive, and could prove to be important technical support. Its a very complicated case 😉 as it feels like continued upward momentum could be linked to m&a at a time where consumer staples like KHC could face headwinds from a border adjustment tax, rising dollar in a rising rate environment that might make the group look expensive.

Short dated options priced should settle a bit, possibly seeing 30 day at the money implied volatility retreat back towards 16%, but in the meantime long holders might look to add yield by selling short dated out of the money calls.