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https://www.wsj.com/articles/the-failure-of-kraft-heinz-11550803181

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The Failure of Kraft Heinz and the Future of

Big Food
Radical cost-cutting is out of favor. Investing in brands to capture changing consumer tastes is in.

Critics say aggressive cost-cutting by Kraft Heinz has damaged its brands. The company reported a 14% decline in fourth-
quarter Ebitda.
PHOTO: TIFFANY HAGLER-GEARD/BLOOMBERG NEWS

By
Aaron Back and Carol Ryan
Updated Feb. 22, 2019 12:59 pm ET

The
Kraft Heinz
KHC 1.87% ▲
experiment in radical cost-cutting has failed. For the broader
food industry, investments in innovation and brand-building are coming back into style.
Investors and companies must now adjust accordingly.

The food giant backed by Brazilian private-equity firm 3G Capital and Warren Buffett’s
Berkshire Hathaway
announced an avalanche of bad news Thursday, sending shares down
27% in Friday trading. The company missed earnings estimates, issued weak guidance for
2019, slashed its dividend, took a $15 billion write-down on the value of some of its most
famous brands and told investors that the Securities and Exchange Commission is
investigating its accounting practices.

Critics have long contended that 3G’s cost-cutting went too far and came at the expense of
growth. They were right. Starting in the first quarter of 2017, the company’s U.S. organic
sales declined from a year earlier for six quarters in a row; organic sales strip out
portfolio changes and currency impacts.

The company’s disastrous results this week further validate the criticism. Shares are now
down by more than half since the merger of Kraft and Heinz in 2015.

On a conference call, JPMorgan analyst

Kenneth Goldman
argued the write-down of the
Kraft and Oscar Mayer trademarks could be seen as a de facto admission that the
company’s cost-cutting strategy has damaged its brands. In a note, Mr. Goldman pointed
out that the company’s guidance for adjusted earnings before interest, tax depreciation
and amortization next year is no higher than Heinz and Kraft’s combined Ebitda in 2014,
suggesting the merger has created no value.

The humiliation of Kraft Heinz will come as a relief to the harried of bosses of rival food
companies, particularly Europe’s lumbering giants
Unilever,
Danone
and
Nestlé.
It was
Kraft Heinz’s botched bid for Unilever in early 2017 that triggered a wave of cost cuts at
Europe’s big-name consumer brands, which have traditionally been run less efficiently
 than their U.S. counterparts.
Bitter Lesson
Kraft Heinz share price since the 2015 merger
Unilever, which makes Dove soap and Lipton tea,
$110 and dairy company Danone promised to take a
100 combined $8 billion in costs out of their
90 businesses. Nestlé, under siege by Third Point
80 activist
Daniel Loeb,
succumbed to pressure and
70 set an operating-margin target for the first time
60 in the company’s recent history.
50

40 Activist investors will now have a tougher time.

30 Consumer companies were the third-most-
20 targeted of all sectors in 2018, according to
10 Lazard data, and are probably still vulnerable—
2016 ’20 but hedge funds will have to bring fresh ideas to
As of Dec. 6
Source: SIX
the table. Elliott Advisors, for example, needs to
do more than push for simple cost cuts to push
Flavor of the Month up margins at Jameson whiskey owner
Pernod
Number of activist campaigns by sector, 2018 Ricard
to the level of Guinness parent
Diageo.
0 20 40 60
On Wall Street today, investors are looking for
Industrials
growth from food companies. That requires
spending on innovation to keep up with rapidly
Energy
changing consumer tastes, as well investments
in marketing. Tellingly, when Third Point
Consumer
mounted an activist challenge to
Campbell Soup
Technology last year, the main criticism was that the
company wasn’t investing enough to update its
Financial
aging soups. For their part, both Unilever and
Institutes
Danone expect sales growth to be at the low end
Healthcare of their targets in 2019 and could do with some
breathing room to focus on their top-lines.
Source: Lazard

One of the best success stories in food recently

has been
Conagra Brands,
which presented itself as something of an anti-Kraft Heinz,
preaching the importance of investing in and nurturing brands. Conagra successfully
turned around aging frozen-food brands Healthy Choice and Marie Callender’s by
incorporating fashionable ingredients like kale. Conagra’s success will be tested with
Pinnacle Foods, which it acquired for $8.2 billion, only to be hit shortly afterward by a
sudden downturn in Pinnacle’s sales.

Another popular Wall Street strategy that now looks defunct is the practice of buying into
companies that seem likely to be 3G’s next target. This explains why Campbell Soup and
J.M. Smucker,
two companies that in the past have been rumored to be in Kraft Heinz’s
sights, fell 7% and 5%, respectively, in Friday trading.

Kraft Heinz managers themselves seem not to have gotten the memo yet that they are less
welcome. On Thursday’s conference call, Kraft Heinz chief executive and 3G partner
Bernardo Hees depicted the company’s dividend cut as part of an effort to strengthen the
balance sheet for future acquisitions. That seems fanciful. Food companies around the
world have new ammunition to argue that a merger with Kraft Heinz would only destroy
value.

This doesn’t mean food companies can relax. They have an urgent task to find ways to
appeal to modern consumer tastes. That can be much harder than cost-cutting.
 Write to Aaron Back at aaron.back@wsj.com
Round Trip
Kraft Heinz adjusted earnings before interest,
taxes, depreciation and amortization

$10 billion

0
2014 ’15 ’16 ’17 ’18 ’19

Note: 2014 is the combined total of Kraft Foods and

H.J. Heinz before the merger. 2019 is the midpoint of
the company's forecast
Source: The company

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