Continued Debt Reduction Improves the Safety of Kraft Heinz's Dividend

Kraft Heinz has paid off over 30% of its book debt during the past four years. Leverage has fallen significantly to reach management's target level, and the packaged food giant's credit rating was upgraded to BBB earlier this year (up from BB+ in 2020).

Recognizing the company's much improved balance sheet and minimal debt maturities through 2025, we are upgrading Kraft Heinz's Dividend Safety Score from 50 to 60 within our Borderline Safe bucket.

The business has undergone a favorable shift in strategy, too. Following the merger of Kraft and Heinz in 2015, the combined company's private equity owners tried driving earnings growth by stripping operations down to the bone.

While Kraft Heinz achieved industry-leading margins, it had little to show in the way of profitable organic growth and pricing power. And market share losses began to pile up as the healthier eating trend further dented demand for Oscar Mayer hot dogs, Cool Whip pie topping, Jell-O gelatin desserts, Lunchables snacks, and other legacy brands.

Coupled with an aggressive use of debt, these challenges came to a head in 2019 when Kraft Heinz cut its dividend by 36%. The payout has been frozen ever since.

Management pivoted in 2020, putting the consumer at the center of everything by increasing spending on marketing and product research and development. For example, in the third quarter of 2023, marketing spend was up 25% compared to the prior year.

The company also shed several business lines, such as natural cheese, that faced the most competition from cheaper products. Approximately 12% of Kraft Heinz's portfolio has exposure to private label today, down from 19% several years ago and below the industry average of roughly 20%.

These improvements have helped the mac and cheese maker deliver moderate but steady organic sales and profit growth despite cost challenges from inflation and shifts in consumer spending patterns.

Looking further out, Kraft Heinz targets long-term sales growth of 2% to 3%, driven by solid contributions from foodservice and emerging markets. Adjusted earnings per share are expected to grow by 6% to 8% annually beginning in 2025 after the firm's growth-oriented capital investments moderate.

If management's forecasts are realized, Kraft Heinz could consider increasing its dividend at a mid-single-digit pace since the firm's payout ratio is in line with the industry average. 

Overall, Kraft Heinz has taken meaningful steps in recent years to improve the performance of its business and reduce financial risk.

The stock has become a more reliable income investment. But investors still have to be comfortable with the company's brand portfolio, which may not align as closely with the current consumer trend towards organic and healthier options, especially when compared to competitors such as General Mills.

Kraft Heinz's geographic footprint and growth potential would also benefit from more exposure to emerging markets (international markets account for less than 25% of sales).

We will continue monitoring Kraft Heinz's performance, providing updates as needed. For now, the company has potential to resume moderate dividend growth within the next couple years.