As tepid as Kraft Heinz's (NASDAQ: KHC) Q1 results and guidance for Q2 are, they aren’t bad. The results and guidance align with the company’s forecast for Q1 and the analysts' forecasts for Q1 and Q2, which are for steady business, a return to growth, and a widening margin. The company didn’t post top-line growth in Q1 and missed the consensus mark. However, the miss is slim and compounded by margin strength that reflects the long-term outlook. Kraft Heinz is widening its margin, growing earnings despite revenue weakness, and setting up a leveraged rebound when volume growth resumes. That is expected soon.
Kraft Heinz Slow and Steady Progress Builds Leverage
[content-module:CompanyOverview|NASDAQ:KHC]Kraft Heinz struggled in Q1 with inflation-driven price increases impacting volume, leading to a revenue contraction. The company posted $6.41 billion in Q1, a decline of 1.2% that missed the consensus mark by a slim 30 basis points. The top line was impacted by a 0.6% negative FX headwind and a 0.1% impact from divestiture, so the miss should be easy to overlook.
Organic sales declined by a smaller 0.5% on a 2.7% increase in pricing, offset by a 3.2% decline in volume. North America and internationally were weak, with 1.2% and 1.3% contractions offset by a 5.5% gain in Emerging Markets. Emerging markets are one of the company’s growth pillars and helping to sustain the positive outlook.
The margin news is reasonable, if not better than expected. The gross margin improved by 240 bps and the adjusted gross margin by 170 bps, leading to increased operating and adjusted operating income. Operating income includes the impact of commodity hedging; adjusting for that, operating income is up 1.7% compared to the top-line decline, attesting to the effectiveness of management's efforts at positioning the business.
Guidance is just as solid. The company reaffirmed its outlook for the year, including a slight improvement in the margin outlook, 25 basis points at both ends of the range. Organic sales are expected to be flat to up 2%, with a 2% to 4% increase in earnings. Price will likely impact revenue and earnings throughout the year, and volume is forecast to resume growth in the second half.
Kraft Heinz Results Unlikely to Alter the Analyst's Expectations
Kraft Heinz analysts will likely make small revisions to their estimates and price targets, if any. The results and guidance align with the consensus forecasts, which suggests that the range of targets may narrow, increasing the probability that consensus is on target. Until the revisions come in, the consensus rating is to hold with a price target of $40.50. The rating and price target are steady, suggesting a 12% upside is possible. The next significant catalyst for KHC will be the next earnings report, which is due in August.
[content-module:DividendStats|NASDAQ:KHC]Capital return is one of the reasons why analysts hold this consumer staple stock. The stock pays nearly 4.5% dividend yield with the post-release price drop, and the reliable payout may be increased within the next twelve to twenty-four months. The company is improving its earnings, lowering its payout ratio, and building leverage for a rebound that should begin this fiscal year. Corporate leverage is low, about 0.4X equity, leaving the company in a position to invest while paying dividends and repurchasing shares. Share repurchases reduced the count by nearly 1% average in Q1 and should continue opportunistically as the year progresses.
The price action in KHC is down nearly 7% following the news, providing an opportunistic time to buy. The move may continue lower, but it cannot go much lower. Support targets near $35 align with the low end of the analysts' target range and are a likely floor for price action. The stock is also trading below 12X this year’s and next year’s earnings forecasts, which include growth, opening up a deep-value opportunity in the turn-around story.
