Reasons why I do not invest in Kraft Heinz or Anheuser-Busch for my dividend growth portfolio

Financial news was dominated by the financial results, the dividend cut and the SEC's investigation announced by Kraft Heinz Co. (KHC) on the evening of February 21, 2019. The company retained a loss. non-recurring value of $ 15.4 billion to amortize the acquisition gap and the intangible assets of the brand marks Kraft and Oscar Mayer. In addition, Kraft Heinz announced a subpoena to the SEC regarding its accounting policies and internal controls in October. The company also missed revenue and BPA estimates for 4Q2018. More importantly, he announced a dividend of only $ 0.40 per share, which had been reduced by $ 0.625, a decrease of about 36%. The stock created a crater in response and dropped nearly 30% in one day.

I have periodically considered creating a position at Kraft Heinz, but I have not done so yet. Despite the reduction in the dividend, the drastic drop in the share price has reduced the dividend yield to more than 4.5%. The stock is undeniably cheap and is trading at a P / E ratio of about 11.0. The stock has dividend growth potential. I asked myself, "Do I have to buy?" Several authors of Seeking Alpha have recently argued that there was value in the stock. But my answer, as in my previous article on Kraft Heinz, is always the same: I stay away. This brings me to the reasons why I do not buy Kraft Heinz, Anheuser-Busch InBev SA / NV (BUD) or even Restaurant Brands International Inc. (QSR) for my dividend growth portfolio. These are all companies controlled and managed by 3G Capital. I will explain the reasons below.

Some brands of Kraft Heinz

(Source: CNBC)

Dividend cuts

I tend to focus on investing in dividend growth. Reducing dividends will certainly prevent me from investing in a stock. In the case of Kraft Heinz, I had anticipated (in my previous article) a low dividend growth due to a payout ratio of over 65% on a BPA-adjusted basis and an even higher payout ratio on a diluted basis. In addition, the payment of the dividend absorbed too much of the FCF. In any case, I thought the dividend would be kept flat and uncut. But my assessment at that time was too optimistic. A payout ratio of 65% is a level that I consider to be the threshold for buying a dividend growth security. In the case of Kraft Heinz, my quantitative screen prevented me from making a purchase.

In the case of Anheuser-Busch, the company reduced its dividend by 50% in October 2018. It added to a previous reduction in 2017. Although the two companies are very different, they both had high distribution ratios which, in my opinion, were unsustainable. The chart below shows a selection of financial statistics. In addition to high payout ratios, dividends from both companies were also high compared to FCF. This indicates that they needed to use cash on hand or increase their debt to pay their dividends.

Clearly, one way to address this shortfall is to reduce the dividend payout, as has been done for both companies. Notably, the distribution ratio of Kraft Heinz is now around 55% and that of Anheuser-Busch about 40%, which is more sustainable. Although the distribution ratios are now lower and dividends are better covered by the FCF, I do not buy shares if the dividend has been reduced recently.

Select financial statistics for Kraft Heinz, Anheuser-Busch and Restaurant Brands International

	Distribution ratio (2017)	Long-term debt	Interest (3T2018)	FCF (3T2018)	Dividend paid (3T2018)
Kraft Heinz	76%	$ 30,998 million	$ 327 million	$ 514 million	$ 762 million
Anheuser-Busch	145%	$ 110,774 million	$ 946 million	$ 1,095	$ 5,132 million
Restaurant Brands International	50%	$ 11,167 million	$ 132 million	$ 354	$ 210 million

(Source: Morningstar data, note that Kraft Heinz is paying an interim and final dividend, so the FCF and dividend data are dated 2Q2018.)

From this point of view, Restaurant Brands International has comparatively better statistics. Its payout ratio in 2017 was about 50%. The dividend has increased since 2017. The same is true for the payout ratio of about 75%, a value that I consider too high and unsustainable in the long term. I expect dividend growth to slow significantly in the near future.

Long-term debt

Another area I focus on is long-term debt. Excessive debt reduces financial and operational flexibility, with interest payments and deleveraging absorbing too much cash flow. The debt levels of the three companies are shown in the table above. My quantitative screen requires the debt ratio (D / E) to be less than 2.0. In this perspective, Kraft Heinz's D / E ratio is 0.5, Anheuser-Busch is 1.12 and Restaurant Brands International is 5.49. Kraft Heinz and Anheuser-Busch meet my goals, but not Restaurant Brands International. In addition, the interest coverage tends to be satisfactory only 4.5 for Kraft Heinz, about 3.5 for Anheuser-Busch and about 3.5 for Restaurant Brands International.

From my point of view as a small investor, the main one is that the average weighted interest rate increases for Kraft Heinz and Anheuser-Busch, as shown in the table below. This indicates that companies are refinancing existing debt and issuing new debt at higher interest rates. In this respect, Restaurant Brands International operates better, with its weighted average interest rate decreasing.

Normally, a highly indebted business with decent cash flow could reduce debt servicing costs and pay interest expense. However, 3G Capital already manages its companies at the right and has high operating margins. This means that there is no important place to improve. For example, Kraft Heinz's operating margins peaked at 25.8% in 2017 and have since declined to a value closer to 20%. These two values ​​are always superior to those of its competitors in the consumer staples sector, which are generally medium to high teens. For example, General Mills Inc. (GIS) has margins of about 17%, while Mondelez International Inc. (MDLZ) has margins of about 15%. This difference suggests that Kraft Heinz has little leeway to improve the margins of deviation.

In the case of Anheuser-Busch, the company has significantly higher margins than its competitors. For example, Molson Coors Brewing Co. (TAP) has only margins of about 15.9% in 2017, only half of those of Anheuser-Busch. This important difference also suggests that Anheuser-Busch will not be able to significantly improve its margins in order to pay interest expense and reduce its debt.

Similarly, Restaurant Brands International has higher margins than its competitor Yum Brands Inc. (YUM), with margins of 27.9%. Once again, Restaurant Brands International has little room for maneuver to improve margins and reduce debt.

Select financial statistics for Kraft Heinz, Anheuser-Busch and Restaurant Brands International

	Interest charges (2016)	Interest charges (2017)	Operating margin (2017)
Kraft Heinz	3.8%	4.4%	25.8%
Anheuser-Busch	3.7%	4.0%	31.2%
Restaurant Brands International	5.1%	4.3%	40.0%

(Source: Morningstar data)

In fact, with inflationary pressures due to commodity inputs and transportation costs and the low ability to raise prices, I think margins will decrease. In turn, this will reduce financial flexibility in terms of debt repayment and the payment of interest expense.

Future acquisitions

3G Capital likes to acquire businesses and grow. He generally pays in cash by issuing debt securities associated with common shares or preferred shares to partners such as Warren Buffett's Berkshire Hathaway (BRK.A, BRK.B). However, given the high debt levels of Kraft Heinz and Anheuser-Busch, the recent loss of earnings, higher interest expense and higher costs, it is unlikely that any other significant acquisition would have occurred. place in the near future. In addition, investment partners can be difficult to find. 3G Capital said deleveraging was a priority for both companies. I believe this effort is to position the two companies for another important acquisition. Clearly, one way to reduce leverage is to reduce the dividend payout and free up cash to pay off the debt early. Although this has already been done, it is possible that the dividend will not grow and future dividends will be reduced to an even faster level.

Last thoughts

Although acquired businesses can create shareholder value, most small investors in Kraft Heinz and Anheuser-Busch have experienced dividend reductions, limited share buybacks and relatively low relative stock performance. Kraft Heinz has higher margins than the industry, but its performance does not look as good as its rivals. In addition, margins are falling to levels close to the industry average. Anheuser-Busch is the largest beer company in the world and the undisputed market leader in many countries. The company is certainly able to return money to shareholders after a period of deleveraging. But I'm not sure that will happen because another acquisition seems to be the priority. For its part, Restaurant Brands International is well positioned to grow. The company has the brands to grow on a global scale. But at the same time, I am not a buyer, because I do not know if 3G Capital will make another acquisition and reduce the dividend to free it from less.

Disclosure: I am / we are long GIS. I have written this article myself and it expresses my own opinions. I do not receive compensation for this (other than Seeking Alpha). I do not have any business relationship with a company whose actions are mentioned in this article.