Food giants haven’t gone so well together
kraft heinz marriage has turned out to be ‘a very risky strategy’
WE’RE ACTUALLY IN A HIGHER COST OF GROWTH ENVIRONMENT, WHERE CONSTANT REINVESTMENT IS NECESSARY. YOU CAN’T CUT YOUR WAY TO PROSPERITY. — ROBERT MOSKOW, AN ANALYST AT CREDIT- SUISSE WHO TRACKS KR AFT HEINZ
The 2015 merger between Kraft and Heinz created one of the largest food companies in the world. It had US$ 28 billion in combined annual revenues and controlled dozens of food and beverage brands that for generations were staples of households, including Heinz ketchup, Kraft cheese, Oscar Mayer meats and Planters nuts.
These days, however, the mega- merger is a megamess.
Sales and profits have slumped. After taking a US$ 15.4- billion writedown in February and slashing its dividend by a third, the company reduced the value of its assets by an additional US$ 1.22 billion last month. Securities regulators are looking into its accounting, and after an internal investigation uncovered employee misconduct, Kraft Heinz said it would restate its financials for 2016 and 2017. It faces numerous shareholder lawsuits. And after laying off thousands over four years, it announced more job cuts in August.
For Brazilian-based investment firm 3G Capital and Warren E. Buffett’s Berkshire Hathaway, the deal has so far been a rare — and costly — misstep. While their earlier acquisitions have produced big returns, the Kraft Heinz deal has created billions of dollars in paper losses. The company’s stock has plummeted 51 per cent in the past year. Last week, 3G sold more than 25 million of its Kraft Heinz shares, bringing its stake down by almost 10 per cent.
Some analysts and former Kraft Heinz employees place much of the blame at the feet of 3G and its use of a highly vaunted “zero-based budgeting” strategy that critics say focuses more on cutting costs than creating products that people want to buy.
Others analysts note that the company’s profit margins are much higher than at peers like General Mills and Kellogg. They argue that Kraft Heinz is facing the same headwinds as other large packaged goods companies, struggling to adapt as the public turns to healthier, and often organic, foods.
There is also competition from retailers like Walmart and Kroger, which have private-label brands. In August, Target announced plans for its own line of grocery products that it expects will include more than 2,000 items and become a multibillion-dollar brand by the end of next year.
“Kraft’s problems are in the marketplace,” said Jim Peterson, a former Kraft executive who left before the merger and is now the chief financial officer for Price Chopper Supermarkets. “Do its products have the same appeal as they used to? How are they going to grow revenues? That’s the dilemma they’re in, and it’s not easily answered.”
The person who will have to try is Miguel Patricio, who took over as chief executive in June.
“To truly change the direction of a business like ours, we need to understand the future, know where the consumer’s needs and the marketplace are headed — and then invest quickly and consistently to make sure our core brands address those needs better than our competitors,” Patricio said in a statement.
Patricio declined to address questions about what happened before he arrived at the company, saying he was focusing on the “next phase of growth.”
He came to the company from Anheuser-busch Inbev, which 3G created in 2008 when it orchestrated the takeover of U. S. beer giant Anheuser- Busch by its company Ambev.
More acquisitions followed. In 2010, 3G acquired Burger King and took it private. In 2013, it teamed up with Buffett’s Berkshire Hathaway on a US$ 23- billion takeover of H. J. Heinz. In 2014, the pair acquired Canadian doughnut chain Tim Hortons, merged it with Burger King and named the entity Restaurant Brands International.
In nearly all its deals, 3G’s strategy is fairly simple: slash expenses, improve profitability and, typically, increase revenues by acquiring other companies. Repeat. The firm’s zero- based budgeting requires managers to justify every expense on an annual basis, not just build on the previous year’s budget. (3G did not respond to a request for comment, and Berkshire Hathaway declined to comment.)
When Kraft and Heinz merged, Bernardo Hees, a Brazilian economist who had led Burger King, became chief executive of the combined company. He told analysts that the merger would yield US$ 1.5 billion in annual cost cuts.
Managers and employees inside Kraft said they had spent long hours and weekends after the deal closed gathering data on everything from expected travel expenses to estimates of how many paper copies their departments would make that year. Those figures were stuffed into voluminous spreadsheets and given to 3G.
That became the foundation for 3G’s cost- cutting. Travel for some departments was cut in half. There were no more colour printouts of presentations. Office snacks — like the free Kraft cheese and Planters nuts that employees could grab between meetings — were eliminated.
The biggest cuts came in staffing. In August 2015, about a month after the deal closed, Kraft Heinz laid off 2,500 employees, roughly five per cent of its global workforce. That included around 700 people, or about a third of the staff, at Kraft’s headquarters in Northfield, Ill. In November, Kraft Heinz announced plans to shut down seven plants in the U.S. and Canada, cutting 2,600 more jobs.
From London to Chicago, important responsibilities once divided among multiple employees, like market analysis and negotiations with supermarkets, fell to a single individual or a small group. With each round of layoffs, those who remained became increasingly dispirited, according to former employees.
Kraft personnel, including some with decades of experience, were replaced by 3G leaders, some of whom had virtually no experience in the consumer packaged goods industry, said Robert Moskow, an analyst at Credit- Suisse who tracks Kraft Heinz.
“In other 3G companies, that strategy injected new energy and a new way of thinking and a way to get rid of sacred cows,” he said. “But it’s a very risky strategy.”
For the first year or so, it appeared the strategy was paying off. Kraft Heinz’s stock price climbed, and in early 2017 it offered to buy European conglomerate Unilever for US$143 billion. After being rebuffed, Kraft Heinz withdrew the offer.
Problems soon began to emerge. Sales started softening, and while 3G’s cost- cutting efforts resulted in robust profit margins, the stock dropped as investors got nervous.
This year, Kraft Heinz acknowledged that its problems ran deep. The company disclosed it had received a subpoena from the U. S. SEC related to an investigation of its accounting. And in February, the company took the US$ 15.4 billion writedown, signalling that its beloved brands were less valuable than when it acquired them four years ago.
Part of the issue, analysts say, was that 3G made its cuts when Kraft Heinz should have increased research and development to compete with the startups increasingly taking shelf space away from food giants. In 2014, before the merger, Kraft spent US$ 149 million on R& D. In 2017, the combined Kraft Heinz spent US$ 93 million, according to regulatory filings.
Other major food manufacturers are learning from Kraft Heinz’s mistakes. General Mills has managed to improve its margins while introducing new products. Mondelez, the snacks giant, has invested in smaller food startups.
“We’re actually in a higher cost of growth environment, where constant reinvestment is necessary,” said Moskow, the Credit Suisse analyst. “You can’t cut your way to prosperity.”