A few short days after its interest in Unilever (ULVR) was made public, Kraft Heinz (KHC) has abandoned its bid. On February 17 the firm had offered $50 per share for Unilever, or $156 billion on an enterprise basis, equating to around 17-18 times trailing earnings before tax.
Morningstar analysts had speculated that Kraft Heinz would need to up the ante above the 18% premium to Unilever’s stock price prior to the announcement. But it has also been reported concerns over culture, particularly surrounding 3G’s stringent cost-cutting and whether that stood to impair the inherent brand equity across its packaged-food and household and personal-care operations, led to the decision. Overall, this news fails to alter our fair value estimates of $69 for Kraft Heinz shares and £36 for Unilever shares, which remain in place.
Kraft Restricted from Making Second Offer
In accordance with the U.K. takeover code, Kraft Heinz is restricted from making another approach toward the European consumer products firm for the next six months. However, while this takeover has been thwarted, we doubt its interest in consolidating the space has subsided. It is far from clear where its intentions lie, but Kraft Heinz could opt for a partner with large exposure to faster-growing emerging markets – where it lacks, representing a mere 10% of total sales. It will also look to reduce costs, as the Unilever merger offered both.
However, we don’t expect Kraft Heinz will opt for a hostile tie-up, as evidenced by its quick decision to end its pursuit of Unilever. We’ve long thought Mondelez could fit the bill, but the strides the wide-moat snacking firm is making to bolster its profitability, signal that reuniting Kraft’s North American grocery operations with its former global snack business may be less likely now.
Beyond the strategic attractiveness, we predict that its interest in a tie-up with Unilever indicates Kraft Heinz’s openness to a transformational deal, as well as its willingness to extend outside its core packaged-food focus. Unilever generates more than half of its sales from its household and personal-care operations. Both of these factors could ultimately stand to add another layer of risk in its future pursuits.
Kraft Will Struggle to Increase Margins
We have not wavered from our thinking that Kraft Heinz’s ability to drive material margin improvement off of recent levels remains limited. With operating margins in the mid-20s, we’ve been of the opinion that the intense competitive landscape and the subsequent need to invest behind its brands to bolster top-line performance, will eat into margins.
This is combined with the likelihood for increased input cost inflation pressures ahead; management has cited its expectations for higher bacon, cheese, and coffee costs in the year ahead, versus recent deflationary trends. Its pursuit of Unilever, where operating margins hovered in the mid-teens in fiscal 2016, could suggest that management recognises the need to look elsewhere to fuel additional margin gains.
