Kraft Heinz (NASDAQ:KHC) doesn’t look like a cheap stock at first sight. The stock trades at a price-to-earnings (P/E) ratio of just under 30 and the shares are only down around 3% this year and 5% in 12 months.
Buying shares that trade at high multiples can be risky. The recent sell-off in growth stocks demonstrates this quite well.
In my view, there’s much more to this stock than meets the eye though. I think that it’s a cheap stock that can give my dividend income a real boost.
Kraft Heinz
In my view, there’s a lot to like about Kraft Heinz as a business. First, it makes products that I think will likely experience stable demand even in a recession.
Second, the company has been using its cash to improve its balance sheet. There’s still debt in the company, which creates risk going forward, but total debt has reduced by around 33% over the past five years.
And there’s a dividend, which yields around 4.5%. With interest rates rising, there’s a danger that this might not look attractive in the future, causing the stock to fall, but I think it looks like a good source of passive income at the moment.
Finally, Warren Buffett owns around 25% of the company and has done so for some time. This means that the company will likely have a source of capital if things get difficult.
All of this makes me think that Kraft Heinz is a stock I’m happy owning in my portfolio. But are its shares cheap at today’s prices?
Valuation
Kraft Heinz shares trade at a P/E ratio of nearly 30, which is higher than Apple (23), Netflix (20), and Visa (26). This makes the stock look expensive, but I think that it’s misleading.
The company reported a net profit of $1.2bn over the last 12 months. But that number is the result of subtracting an asset impairment charge of around $2bn from its operating income.
An asset impairment charge involves the company lowering the accounting value of its assets. In the case of Kraft Heinz, the company has a lot of intangible assets in the form of brands.
This doesn’t involve any cash leaving the business. But it still shows up as a cost in the income statement and makes the company’s net income number lower.
I think this means that Kraft Heinz’s net income doesn’t accurately reflect its profitability. In my view, the $3.2bn in free cash that the business generated over the last year is a better metric.
Non-cash charges, such as asset impairments, don’t affect free cash flow. So I think that looking at the company’s cash flow statement gives a better view of how cheap its shares are.
At today’s prices, the stock trades at a price-to-free-cash-flow (P/FCF) multiple of around 15. Viewed this way, the stock is clearly cheaper than Apple (24), Netflix (635!) or Visa (29).
A stock to buy
As a stock, Kraft Heinz certainly isn’t without risk. But I think that it’s well-protected from the risks that come with owning an expensive stock.
The company’s strong cash generation and attractive dividend give me confidence in owning its shares. At today’s prices, I’m looking to keep buying.
