Moody's begins reviewing Kraft Heinz's credit rating due to separation plan

Kraft Heinz's plan to split its business has triggered a downgrade review of the food giant's credit rating by Moody's. Kraft Heinz shares fell 7% in a day, but still do not seem attractive to professional investors.

On September 2, Moody's decided to place the ratings on Kraft Heinz's senior unsecured debentures (i.e., those due first) and commercial paper on review with a possible downgrade. The former are now at Baa2, the latter at Prime-2. The agency changed the outlook on all Kraft Heinz structures from "stable" to "under review".

Moody's intends to assess both the potential benefits and risks of the Kraft Heinz demerger announced the day before into two independent assets. These will be companies with the temporary names North American Grocery (Oscar Mayer sausages and hot dogs, Kraft Singles processed cheese and Lunchables snacks) and Global Taste Elevation (Heinz sauces, Philadelphia cheese, Kraft Mac & Cheese). While this "divestiture" may result in greater focus on their respective segments, both companies will get "brands that have reached a high degree of maturity in their core market while consumers are cutting back on spending," the agency said in a statement.

It will examine, among other things, "the risks associated with implementing the separation, the operating prospects of the Taste Elevation and NA Grocery businesses, and the planned final capital structures and financial policies of both companies," Moody's wrote.

The road to the Kraft and Heinz merger began in 2013 when billionaire investor Warren Buffett teamed up with Brazilian investment firm 3G Capital to buy HJ Heinz. The $23 billion deal was, at the time, the largest in food industry history. Kraft Foods, meanwhile, was looking for a partner after spinning off its snack food business in 2011, which became Mondelez International. In 2015, Buffett and 3G decided to merge Heinz and Kraft. This created the world's fifth-largest food manufacturer with annual revenues of $28 billion.

The idea was to improve profitability through scale - the prevailing thinking at the time was that the larger the holding company, the more savings could be made in accounting and similar services, Russell Zwanka, an economist at Western Michigan University, recalled in a conversation with the Associated Press. But the fashion for healthy eating has made that plan more difficult to realize - consumers have begun turning away from the highly processed foods Kraft sells. Kraft Heinz's effort to eliminate artificial flavors and colors has incurred additional costs but has not led to a significant increase in sales.

As a result, the company is among the worst players in the industry over the past decade, Barron's writes. The food giant's revenue forecast for 2025 is about $25 billion versus $26 billion in 2016, and its projected earnings per share is $2.6 versus $3.4 in 2016.

Kraft Heinz shares, like many other food makers, are trading cheap at about 10 times the ratio of projected 2025 earnings to share price, Barron's notes. Meanwhile, their dividend yield is about 6%, one of the highest in the S&P 500 index. In announcing the split, Kraft Heinz promised to maintain the current dividend level "in aggregate."

Victoria Fernandez, chief market strategist at Crossmark Global Investments, told Yahoo Finance on Sept. 2 that even after Kraft Heinz shares collapsed 7% in a day, she would prefer to invest in PepsiCo. While the popularity of weight loss products is affecting that company as well, the arrival of activist investor Elliott Management at PepsiCo could push it to make changes to close the gap with Coca-Cola, Fernandez said. PepsiCo also has other growth points, such as energy drinks, a segment where consumer preferences are shifting, she added.

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