Tags: Heinz | Kraft | junk | 3G

Junk Food's Last Stand

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Wednesday, 01 April 2015 08:54 AM Current | Bio | Archive

Neither Heinz nor Kraft is in good shape. Will merging the two help? Don't count on it.

Last week's merger announcement was certainly good news for Kraft (KRFT) shareholders. Their shares shot up more than 30 percent and they'll get a very nice $16.50 special cash dividend, too. Nevertheless, the real winners were in Omaha, Neb., and Rio de Janeiro, Brazil.

You know the Omaha connection. Warren Buffett's Berkshire Hathaway (BRK.A) owned a chunk of Heinz in partnership with a Rio-based private equity firm called 3G Capital.

Buffett and 3G are making out like bandits. They took Heinz private two years ago in a massive leveraged buyout. Estimates show they have roughly tripled their money in that time.

Better yet, buying the much larger Kraft with its Nasdaq listing gives the current Heinz owners instant liquidity. Their Kraft takeover is essentially a back door Heinz IPO. Berkshire and 3G will no doubt begin a slow sell-down and be out of the picture in a year or two.

Meanwhile, 3G will do what it does best with Kraft. Like most private equity shops, they specialize in cost cutting and efficiency. They will be ruthless. Kraft employees had better polish their resumes.

The odd part, however, is that neither company is in particularly good competitive position. The packaged food business is fading fast, all those iconic Kraft-Heinz brands notwithstanding. A growing number of people simply don't want the stuff.

To be sure, some of those child-oriented brands are now strongest among the very people who loved them as children in the 1950s. Millions of baby boomers still buy Miracle Whip and Velveeta — a tribute to the power of early branding.

What those boomers forget, though, is that today's processed food is different from the identically named products they ate as children. Cane sugar all but disappeared from processed foods in the 1980s, replaced by cheaper high-fructose corn syrup.

Other ingredients are different now, too, and the corn and soybeans that go into these products are genetically modified varieties whose safety some consumer groups call unsafe. (That doesn't stop the industry from force-feeding them to Americans, of course.)

The upside of the Kraft-Heinz combination comes almost completely from cost reduction. The company can't innovate, so it will have to squeeze costs. Would anyone buy organic Oscar Meyer wieners? Of course not. That's the other side of having a strong brand. Changing direction is all but impossible.

All that aside, there is one scenario in which this deal is a stroke of genius.

Junk food sells in certain demographics because it is cheap, tasty and filling. Low-income folks like that combination. Kraft-Heinz's best chance for growth will come if that demographic group grows in the next few years.

That's right. If Kraft-Heinz isn't junk food's last stand, it will be because our economy is so weak that junk food is all we can afford.

If you own the stock, consider it your depression hedge. That's the only scenario in which Kraft-Heinz has a future.

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PatrickWatson
Neither Heinz nor Kraft is in good shape. Will merging the two help? Don't count on it.
Heinz, Kraft, junk, 3G
501
2015-54-01
Wednesday, 01 April 2015 08:54 AM
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