Kraft Heinz (KHC) has let investors be shocked by the announcement of a major loss in the Q4 of 2018, fueled by an impressive record of $ 15.4 billion in several brands. The company also revealed a survey of the Securities and Exchange Commission in its accounting practices.
The market sent stocks that pop up after the news. Some fearless investors have suggested buying a dive, but we are not sure. Indeed, the world's fifth largest food and beverage company may further upset investors' stomachs. A closer look at both research and the SEC research shows that things may actually be worse than they already seem to be.
It's not the average of your writing
Based on only the net size, Kraft Heinz writedown is remarkable. At $ 15.4 billion, it is the seventh biggest decline since 2009. The inventory comes from two sources: $ 8.3 billion from an intangible asset registered under the Kraft and Oscar Mayer brands and $ 7.1 billion from the impairment of goodwill in British refrigeration and retail business.
But size is not the issue here. The reason why it is so unusual is that it seems to have come almost from nowhere. Kraft Heinz conducts regular reviews of its various business units, including annual impairment tests. This leads to a fairly regular recognition of the impairment of goodwill, with the relevant adjustment to the balance sheet.
Kraft Heinz typically performs its core impairment testing in the second quarter of each year and in 2018 is no exception. When the company reported Q3 earnings, it recognized significant impairment costs:
"We audit the impairment of goodwill at least in the second quarter or when an event occurs." We conducted the 2018 annual impairment test from April 1, 2018. As a result of the 2018 annual impairment test, we recognized a non-cash impairment loss of 164 mn General and administrative expenses related to the Australia and New Zealand reporting unit, mainly due to the fall in profit margins in the region, the 20 reporting agents each. these had surplus fair value over their book value of less than 10% From the valuation date, the goodwill associated with these reference units amounted to $ 4.7 billion for Canadian Retail Trade, 424 million for Exports Latin America, millions for Northeast Asia, $ 326 million for Southeast Asia, and $ 232 million for other Latin American countries. "
With "five out of 20" reporting agents that obviously have significant redundancies, there was always a chance that things could get worse. But to dramatically change the situation in less than six months is shocking. It is obvious that Kraft Heinz was either away from the blue, or was eager to recognize the true field of harm so far. While the company can try to confirm the confidence that it is a one-off adjustment, the fact that it was not telephoning – and triggered in such a short time – should be considered a serious red flag and a warning that this may not be the end of the matter .
SEC Voting in Books
Writing was not the only thing that blind investors this week. Kraft Heinz also revealed that its accounting practices had been examined by the Securities and Exchange Commission and received a call from the regulator. The company said it had launched its own internal investigation in response to the research of the Capital Market Commission, recording an additional $ 25 million:
"Following this initial SEC request, the Company, together with external consultants, launched a contract research study. In the fourth quarter of 2018, as a result of the research findings, the Company recorded an increase of $ 25 million in the cost of the products sold as off-period adjustment as the Company determined that the amounts were insignificant in the fourth quarter of 2018 and in the previous reported interim and annual periods 2018 and 2017. In addition, the Company is in the process of applying improvements in its internal controls to mitigate the likelihood of this happening in the future and to take other remedies. The Company continues to cooperate fully with the US Securities and Exchange Commission. "
While an SEC research is not something an investor wants to see. However, Kraft Heinz makes it sound like it does everything in the right way: to work together, to start an internal research, to recognize cost adjustments and to promise new controls to prevent repetition of errors. So far so good.
But, again, there is more to this story if we dig a little deeper. According to the timing of the company's own events, it appears that the Securities and Exchange Commission probably intended for reasons other than the $ 25 million adjustment reported for the quarter. Audit Analytics, a specialized research equipment, concludes that history is a long way from:
"In other words, there was another outstanding issue that triggered the SEC's examination, and details of what this issue might be about are not provided for the release of profits or teleconferencing."
If there is more to the investigation of the Capital Market Commission, which certainly has not expired, it could mean more unpleasant surprises on the road.
Demonstration of the investor's eyes
Kraft Heinz dropped 27.5% on Friday, amid analysts' downgrades. The violent reaction of the market would usually cause us to kill around for a buying opportunity. However, in this case, we suspect that there may be more problems ahead.
The main activity obviously suffered a serious blow. A myopic focus on cost reduction has led Kraft Heinz to lose its attention to the retention of its brands, even when consumer preferences continue to change. Today's brands do not meet a new generation of consumers. Meanwhile, he has seen little success in introducing new and profitable demands.
Kraft Heinz has promised a return to strong revenue growth and improved profit margins, focusing on improving its brands, confirming its market position and creating new opportunities. Considering how quickly the consumer market evolved, these commitments seem somewhat dubious.
And even if the company follows its operational promises, other issues remain under the surface. Further weakening of the brand could weaken the stock price and, given the latest surprise, there is no reason to be confident that this was the last major record of the cards. The investigation of the Capital Market Commission is putting even more red flags. It is a big question mark and Kraft Heinz has done nothing to mitigate investors' fears so far.
While investors may think that this dive is worth buying, we will stay on the sidelines until we get more clarity into the long-term prospects of the company in a rapidly changing world.
Revelation: I do not have any positions in any of the listed stocks and I do not plan to start any positions within the next 72 hours. I wrote this article and expressed my own views. I do not receive any compensation for this (except for Seeking Alpha). I have no business relationship with any company whose inventory is mentioned in this article.