(Bloomberg Businessweek) -- Kraft Heinz Co. was supposed to be different. The packaged-food giant, created in a 2015 merger orchestrated by private equity firm 3G Capital and investor Warren Buffett, was viewed, on Wall Street at least, as immune to the headwinds pummeling its peers in the industry.
Sure, it’s tough to find sales growth, with consumers looking for fresher and edgier products and grocers improving their house brands and increasingly giving shelf space to upstart names such as Halo Top and Chobani. But for Kraft Heinz, it almost didn’t matter. The marriage was never about selling more Maxwell House coffee, Kraft macaroni and cheese, and Oscar Mayer deli meats. It was about 3G finding another company to buy and doing what its notoriously thrifty managers do best: slashing costs and making money—big money—for shareholders.
For a while, that’s how it played out. Even as the industry struggled, investors pushed Kraft Heinz to a high of $96.65 on Feb. 17, 2017, a big price-earnings premium to its packaged-food peers. Since then, the shares have plunged roughly 40 percent, wiping out almost $50 billion in market value.
On the February day that Kraft Heinz stock closed at its all-time high, reports hit that the company had offered $143 billion for Unilever, the European household-products giant that makes Dove soap, Hellmann’s mayonnaise, and Ben & Jerry’s ice cream. The bid surfaced right on schedule: four years after 3G and Buffett teamed up to take Heinz private and two years after they’d bought Kraft and merged it with the condiment maker in a $55 billion blockbuster. Each time, 3G had employed a ruthlessly efficient playbook: fire thousands of workers, shutter factories, and produce industry-leading margins. Adding Unilever to the mix would provide even more opportunities for cost-cutting, and applauding investors quickly sent Kraft Heinz stock up 11 percent on the news.
Unilever, though, wasn’t having it. Fearing a culture clash and playing on Buffett’s well-known aversion to hostile deals, Chief Executive Officer Paul Polman pushed back, creating enough dissonance to effectively quash the deal. That’s left investors to ponder a world where Kraft Heinz had to give its investment bankers a rest and actually sell more cheese and hot dogs.
In February 2018 the company said it had, as promised, cut $1.7 billion in expenses by integrating the two businesses. That effectively marked the end of the post-merger period for Kraft Heinz. And with each passing day without a new deal, the outfit looks more and more like any old food company, struggling to reignite growth in its annual sales—$26.2 billion last year—with a portfolio of products whose best days are behind them. (Remember that pickle relish in the back of your fridge?)
Kraft and the nine other largest packaged-food companies in the U.S. have seen more than $19 billion in revenue evaporate over the past three years. And it’s not expected to get much better: U.S. sales in the industry will grow about 1 percent a year through 2022, according to Euromonitor International. An index of the stocks of the 10 largest packaged-food companies is down 16 percent this year, while the S&P 500 has fallen only about 1.5 percent. Worse, that stock slump has come amid increased turmoil in the equity market, which historically would send investors flocking to the safety of food stocks. That’s because people always have to eat, the old market adage goes, no matter the economic environment.
It’s not the case for food stocks this time, at least not yet. “They’re not behaving as defensively as they once did,” says Brittany Weissman, an analyst at Edward Jones.
There’s a shopping cart full of factors conspiring against Big Food. For one, customers are shopping more on the so-called perimeter of the grocery store, meaning the areas where fresh vegetables, fruit, and meat are sold and away from the shelves dominated by packaged-food behemoths including Kraft Heinz. Even in the center of the store, market share is going to younger brands that have resonated with consumers. Some, such as Kind bars and SkinnyPop popcorn, have been around less than a decade, but they already are logging hundreds of millions of dollars in annual sales. Americans are also eating out more frequently, and the rise of meal kits such as Blue Apron, Sun Basket, and HelloFresh has also taken a chunk out of grocery spending.
Then there’s the grocery price war. Amazon.com Inc.’s deal to buy Whole Foods Market has rattled all corners of the food industry. The day the deal was announced, food stocks plunged, with investors betting that the internet giant’s entrance into the market would mean even thinner margins for suppliers.
U.S. consumers are also increasingly shifting their shopping to low-priced outlets operated by Aldi Inc. and the American unit of its longtime German competitor Lidl. About 90 percent of the merchandise stocked by the huge German discounters are private-label items, meaning a shopping trip to their stores is a loss for the big national brands.
Kraft Heinz acknowledges it’s looking for a takeover target and says it expects the changes in the industry will drive further consolidation. But the company also insists it doesn’t need a merger to generate growth. “Kraft Heinz will continue to meet consumer needs around the world—with or without another acquisition,” the company said in a statement, adding it’s “best positioned” to navigate the tough environment thanks to its “iconic brands.”
Even before Amazon, food companies were grappling with a resurgent Walmart Inc., which has improved its food business and now gets more than half its revenue from groceries. Like other retailers, Walmart has invested in its house brands, which boast higher profit margins because they cost it less than branded products from big packaged-food companies—and can be potent weapons in a price war. “Retailers have the edge right now,” says Jennifer Bartashus, an analyst at Bloomberg Intelligence.
Kraft Heinz has sought other ways to raise its bottom line. The company in February announced it would invest $1.1 billion in savings from tax reform toward its supply chain and brands, and it’s repeatedly said it’s committed to nurturing brands and developing products that resonate with consumers. Kraft Heinz recently scored a marketing win on Twitter, generating buzz for its new mayonnaise with a poll asking if it should release a ketchup-mayo mash-up. And the company’s new startup incubator, called Springboard, has partnered with celebrity chef David Chang to take his Ssäm sauce national on Amazon in a bid to grab some foodie cachet. Still, it’s hard to see these efforts moving the needle much.
Most observers still expect Kraft Heinz to make an acquisition to get its cost-cutting playbook back in action. But the stagnant growth in packaged food has also sent rivals on the hunt for deals, leaving targets increasingly expensive. One example: General Mills Inc. paid $8 billion for premium dog food maker Blue Buffalo Pet Products Inc.
In 2017 the premiums paid above market price for deals in the food industry surged 50 percent above the yearly average from 2010, according to Jefferies LLC. So even with the financial backing of Buffett, the ability to squeeze profits from a megamerger will hinge on not overpaying. That means it could take time to find the right target—intensifying the focus on Kraft Heinz’s uphill efforts to sell more food. —With David Russell and Brandon Kochkodin
To contact the author of this story: Craig Giammona in New York at cgiammona@bloomberg.net.
To contact the editor responsible for this story: James Ellis at jellis27@bloomberg.net.
©2018 Bloomberg L.P.
