Since the production of the KraftHeinz (KHC) debacle podcast/vidcast, two publications and one announcement.

With a delay announced in February, the firm published in June its final accounts 2018, including a restatement on the accounts 2016 and 2017. No significant change on the latter, the net earnings per share down from $ 9.03 to $ 8.98 for 2017. However, the 2018 accounts show an exceptional write-off of nearly $ 16 billion in goodwill and intangible assets. Warren Buffett said in CNBC in June: “I made a mistake in the Kraft purchase (author’s note: bought by Heinz in 2015) in terms of paying too much”. At the forefront of the depreciation of assets, the 2018 annual report mentions (page 96) the fall in the stock market price which drove the value of the firm below its book value.

Specifically, with a stock price of $ 33 at the end of January 2019 and 1.2 billion shares outstanding, the market capitalization of KHC amounted to $ 40 billion for a book equity of $ 65 billion at the end of Q3 2018, then it was difficult to maintain that the book value of the assets in the balance sheet reflected their financial worth.Since then, KHC has published the accounts for the first half of 2019: compared to the same period in 2018, slight decline in sales and operating profit (EBIT) with 1.3 billion USD instead of 2.9 (2018), mainly because of a further depreciation of 1.2 billion.

If this “exceptional” item is removed, the EBIT would amount to 2.5 for capital employed (CE) of about 80 billion (equity – 50 + net financial debt – 30). By simplifying the annualization of EBIT (multiplied by 2 …), we obtain a ROCE (EBIT / CE) of 5/80, which is about 6% before taxes. The KHC beta is in the order of 1.2 and its financial debt costs around 4%, hence a cost of capital (WACC) of 6%. The economic profit (EP = ROCE after tax – at the rate of 25% – less WACC) is, therefore, negative, close to -1.5%. Negative EP and a stock market value lower than the book value (bad-will) are two unfortunately consistent observations. Interestingly, the value creation (destruction) ratio Market-To-Book (MTB)  calculated by dividing the enterprise value (EV = market capitalization + net financial debt) by book capital employed is deduced from ROCE and WACC by the following formula:

MTB = 

The factor g represents the long-term growth of free cash flows. If we take the KHC share price in early September ($ 27) and the balance sheet at the end of the first semester, we get a MTB of 0.75. ROCE after tax (previous calculations) represents about 75% of the WACC. Therefore, g equals zero in the formula. This can be interpreted as “the market does not anticipate any growth of free cash flows”, which is consistent with a near stability of sales.What to deduce for the future?KHC announced the appointment of a new CEO, Miguel Patricio, on July 1, 2019. The compensation plan is described at the end of the 10Q published end of August and shows that it is significantly related to the evolution of the stock price. If the new CEO increases the ROCE in a sustainable way, the share price will rise for the good of its shareholders and his personal wealth. If he increases revenue, but does not improve profitability, there will be no value creation, as only profitability creates value in the long-run. But, how to increase the ROCE? By further cost reductions …? Should we anticipate new assets write-offs if the ROCE doesn’t improve?