Could This Be a Red Flag for Kraft Heinz Stock and Its Dividend?
Kraft Heinz (NASDAQ: KHC) is an attractive dividend stock for investors. It offers a high yield of 4.4%, which is more than three times the S&P 500 average of 1.4%. But the business hasn't been growing all that much, and with its high debt load and interest rates remaining elevated, investors haven't been keen on owning the stock in recent years.
Concerns may be rising that Kraft may not be able to maintain its current dividend for the long haul. It has already slashed its dividend payment in the past. Now, with a rumor circulating that Kraft may be looking to offload one of its businesses, could that be a red flag for investors?
Kraft to sell its Oscar Mayer brand?
According to a recent report from The Wall Street Journal, Kraft is exploring the possibility of selling one of its top brands in Oscar Mayer. A deal for the business could generate between $3 billion and $5 billion for Kraft. The company hasn't indicated any such move in its recent filings. It also doesn't break out revenue and earnings by brand, so it's not clear how strongly it may have been performing of late, and whether that could be part of the motivation to sell the brand.
Rumors of potential deals aren't uncommon, and they don't always mean a transaction is imminent. Until there's an official announcement from the company, investors shouldn't assume that anything will happen. But it is worth considering what would be the motive behind a potential move.
Why might Kraft be looking to sell one of its top brands?
Regardless of whether a sale goes through or not, it's worthwhile to consider why Kraft may even be contemplating the sale of one of its iconic brands. After Kraft and Heinz, Oscar Mayer is listed as one of the top beloved global brands on the company's website. If it can fetch a value of around $5 billion, that would represent more than 11% of Kraft's current market capitalization of $44 billion -- it wouldn't be a small sale by any stretch.
Over the past few years, Kraft's business has been fairly stable for the most part, which suggests that a sale may not be due to a particular brand underperforming or due to financial struggles.
KHC Revenue (Quarterly) data by YCharts
One motivation, however, could be to reduce the company's high debt load. While Kraft has been reducing its debt over the years, at more than $20 billion, it's still a hefty amount to be carrying with interest rates remaining high.
A deal that would inject up to $5 billion into Kraft could be enticing to help bring down its debt load and make the stock appeal to investors who may see the stock as too risky to buy given its current debt levels. In five years, the stock has risen by just 11%, while the S&P 500 has generated returns of 86%.
KHC Total Long Term Debt (Quarterly) data by YCharts
Another potential motivation may be to deploy proceeds from a sale toward an acquisition to diversify its business into healthier food options. However, investors won't know for sure what the plan might be until after a deal happens (assuming it takes place at all).
Should investors worry about the dividend?
If a company is looking for additional cash, that may be particularly concerning for a business such as Kraft, which pays a fairly high dividend.
In Kraft's most recent quarter, which ended on March 30, the company reported a diluted per-share profit of $0.66. If it were to maintain that level of profitability, that would put its payout ratio at approximately 61% of earnings, which would appear to be manageable.
There are no reasons for alarm right now. Kraft projects that its organic net sales will grow between 0% and 2% this year, and that adjusted operating income and earnings per share will also increase. Although Kraft did cut its dividend in 2019, it has remained stable ever since. And the company's recent performance doesn't suggest that there's any trouble on the horizon.
But if a deal does take place involving Oscar Mayer, then it's possible Kraft may need to adjust its dividend to reflect being a smaller business, and its profits likely being smaller as well.
Should you buy shares of Kraft Heinz?
Kraft has been an underwhelming investment to own over the years, but rumors of a deal involving Oscar Mayer don't appear to be a cause for concern. The business still seems to be in good shape, and a possible sale may have more to do with reducing its debt or recalibrating its long-term strategy than anything else.
Ultimately, the dividend still looks safe. With the stock trading below its book value, Kraft could make for a good income-generating investment to hang on to, regardless of what happens with Oscar Mayer.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Kraft Heinz. The Motley Fool has a disclosure policy.
