Tag Archives: risk

What’s going on with Kraft Heinz?

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I wanted to take some time to talk about the action this week in Kraft Heinz (KHC). On Thursday, the company reported earnings. Despite significant progress on the cost-cutting front, the headlines were bad. Q4 net sales were down 3.7%. Susquehanna issued a downgrade due to “slower EBITDA growth and delayed deal-making,” as was reported in this Barron’s blog post. Analysts Pablo Zuanic and Aatish Shah even went so far as to predict “little upside in the year ahead.” As a result, the stock finished down $3.82 or 4.2% on Thursday, February 16.

What a difference a day makes.

Turns out that not only is “deal-making” in the air, but the ever-acquisitive Kraft Heinz management had already approached Unilever (a list of their brands that claims 2.5 billion daily customers can be found here) about one of the biggest deals in the history of the consumer food and beverage sector. Weeks earlier.   By the end of the day on Friday, February 17, the tape showed a gain of $9.37 or 10.7%.

In what is being widely reported as a $143 billion offer for KHC to merge with Unilever but in reality may be a much richer offer due to the cash-and-stock nature of what is likely going to be a very complex deal, Kraft Heinz Unilever would instantly become the largest multinational corporation financially engineered by the folks at 3G Capital. And with their folksy financier Mr. Warren Buffet having recently been killing it in the post-election rally and the master Brazilian operator/dealmakers having just raised a massive new round of funding from the likes of Gisele Bundchen and Roger Federer, analysts should have most definitely been aware of the main driver of KHC stock. Yet they published their downgrade anyway. Slathered with a liberal dose of obscure acronyms just to make it sound like they knew what they were talking about.

Egg. Meet face.

This is what happens when analysts get spreadsheet blindness. They start tossing around acronyms and predictions about “trade spending efficiencies” and “synergy realization momentum” to make them sound smarter. But they’re lost in the woods and can’t see the narrative that is really driving the stock. They are being straitjacketed by the scaffolding minutiae they have built into their model. A slight decline in sales due to 3G refocusing on higher-margin brands, a 53rd week of shipments in 2015 that made comparisons tough in 2016, and… Poof!… Their spreadsheet spits out a $1.5 billion decline in earnings before interest, taxes, depreciation, and amortization (EBITDA) projections for 2018.

It’s not the most egregious error that spreadsheet risk has foisted upon the new world economic order. That honor will probably forever belong to Carmen Reinhart and Kenneth Rogoff and their paper that damned Europe to austerity and all its consequences. But jeez, you hope for better analysis to come out of these high-priced New York shops.

Whatever some spreadsheet model is telling you about KHC is simply not the reason to invest in Kraft Heinz. It never has been. Maybe they should have read this article I published on Seeking Alpha way back in October 2015. My thesis for making a long-term investment in KHC back then had everything to do with the blossoming partnership between Berkshire Hathaway and 3G Capital. As I wrote in a speculative post a couple years ago linking them with Coca-Cola (KO), the pair are out to catch some big acquisitions. Their recent investment bounty and successful round of funding only amplifies that sentiment.

Unilever is a big fish. Also, with nearly 60% of its sales coming from emerging markets, it is nearly a perfect fit for Kraft Heinz, which currently only nets 10% of its sales overseas. If it’s not going to be Unilever, as Business Insider has reported, it will be some other food-oriented multinational consumer staples company which, after it gets the “3G treatment” will almost certainly be accretive to earnings. Mondelez. Campbell Soup. Kellogg. General Mills. There are so many fish in the sea.

I like the opportunity so much that KHC is now the fourth-largest position in my retirement portfolio. Warren Buffett is the world’s greatest capital allocator. Jorge Lemann and his cohort have proven themselves to be the world’s greatest operators. The combination should continue to prove immensely beneficial for investors whatever their next target is going to be.

Since the offer came to light early on Friday, Unilever has vehemently and very publicly rejected it. But so did Anheuser-Busch when 3G first floated the idea of acquiring it. Despite a “fierce defense,” a $46.3 billion all-cash offer eventually became a $52 billion offer with a few concessions to the Busch family. These entrenched companies have legions of proud middle managers that refuse to believe that someone could run their business better than them. But 3G definitely can. And will. Combined with their lack of nostalgia over past traditions and good ‘ol boy hires, their love of zero-based budgeting and flat organizational structure offers nearly endless capex reductions. Each bloated bolt-on acquisition offers a new opportunity to wring out the excess.

And realize profits galore.

3G’s dance with SAB Miller was even more drawn out. After nearly a year of haggling, 3G via its suds acquisition vehicle AB-InBev (BUD) downed SAB Miller for $107 billion.

When 3G wants something, it usually gets it.

What is beta?

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Before the Netflix era made watching rare high-quality films as simple as turning on a light switch, the height of late 1970s technology for the hi-fi home entertainment viewing experience looked like this:

View post on imgur.com

When I was young, my father believed that beta videos offered the highest quality means of watching his favorite movies. Technically, he was correct. Betamax videos maintained their integrity for sharing purposes much better than their VHS counterparts. Our family collection included Dune and, of course, all of the Star Wars and Indiana Jones movies. We didn’t need HBO. My dad just copied the movies he liked using a second player. It was a great system.

Somehow, we continued in this fashion deep into the 1980s, when the proprietor of the video store we frequented finally sold off his Betamax video collection. One by one, our “higher quality” home movie theater became more and more obsolete.

I think my dad was the only guy who rented the things from him. Somehow our family still managed to find films to watch. Even as the selection shrunk until it was just a few rows of faded video boxes in the way-back dusty corner of a video shop in a forgotten strip mall.

Thus, for me personally, the word beta is suffused with memories of light sabers, fear of snakes, eating monkey brains, and driving way too far just to rent bad movies.

Other people associate the word beta with their college experience. The college fraternities and sororities of the US are frequently referred to as collections of letters from the ancient Greek alphabet. Beta Theta Pi. Phi Beta Sigma. Alpha Phi Beta. Sigma Beta. Sigma Phi Beta. Beta may be the most widely used letter in this “Greek” system. That must be because it’s easy for folks in the modern Greek life to remember. It looks like a B:

Where else is beta? Everywhere. Beta represents vital concepts in many fields: computing, finance, phonetics, mathematics, rock climbing, and statistics.

Software first gets released in beta so that the developers can discover bugs and inconsistencies that they otherwise could not have found on their own. Gmail was a beta product for five years before Google felt comfortable removing the moniker.

Much in the same way that the symbol for beta is often mistaken for the Roman letter B, concepts represented by beta are often those that we cannot possibly know but absolutely must discern.

In finance, the concept of beta has just this characteristic. Beta is a widely used (as well as widely misunderstood) measure of market risk. It provides the slope of the risk-return tradeoff line for a portfolio as defined by the capital asset pricing model formula.

If you’re looking for the beta of a particular stock, it is provided in all statistical packages and nearly all statistical websites. Let’s take a look at this screenshot from Yahoo! Finance:

View post on imgur.com

Beta is right there circled in red.

In order to interpret this particular stat, you should think that Apple (AAPL) stock in the most recent 36 monthly periods (3 years) has performed as well as the market has plus another 35 percent.

Note:  I do not mean 35 points, I mean percent. So if the market goes up 2% in a month, AAPL should go up 2.7% not 37%. By the same token, if the market goes down 2% in a month, AAPL will go down 2.7% as well.

A stock with a beta of below 1 will have much better monthly returns, on average, in times of market deterioration. In fact, some scholars believe that, in the long run, persistently sub-one betas may also enjoy excess returns.

So “BET AGAINST BETA” and amass low beta investments.

Do it for long enough and you might just become one of the 18% of active fund managers that beat the market over a decade’s time.

Beta is often mistakenly thought of similarly to the correlation of a particular stock to the stock market as a whole. And if we think of the market as an example of the “perfect” amount of risk that a “rational” investor should be willing to take on at any “normal” point in an investing lifetime, then beta can be described as a sort of risk measure. That is, at least, the story from the perspective of contemporary financial theory.

But, technically, beta is not a direct measurement of risk. It can only tell you if a collection of assets has more or less risk relative to a benchmark. And when the benchmark itself swings about wildly as indeed all market benchmarks have recently been doing, it can seem like supposedly low-risk stocks are just as high-risk as any other high-risk venture like a Tesla (TSLA), Chipotle (CMG) or Shake Shack (SHAK).

This risk of rapid price swings that seems to be inherent in all modern financial markets is known as systematic risk. It is said that we cannot diversify this risk away. No matter what magic tricks we deploy to construct a portfolio.

Basically, beta is a comparison of the variability of one single investment with the variability of a chosen market. Because it is comparing a second-order effect, i.e. variability, rather than a statistic more directly linked to company performance, like price level, we cannot accurately state that it is a direct measure of risk. It is most precisely a measure of relative variability that hints at the possibility of risk.

However, beta is an important part of the toolkit a portfolio manager employs to create personalized investment portfolios. Paying close attention to beta levels at the portfolio level maximizes return levels. It puts a reasonable floor underneath your potential losses and significantly diminishes the scope and scale of a portfolio’s risk levels. While a rational investor cannot ever escape their exposure to systematic risk, they can reduce the impact that that risk has on portfolio returns.

And for this reason alone, investors must get to know beta.

Beta is a critically important statistical factor in investment consideration.

But the best reason to prioritize beta analysis in selecting investments is that it is widely available data. For the most part, you don’t even have to calculate it. It is easy to find and, as long as you know exactly what the beta number you are looking at actually means, it is also easy to use to create a portfolio that has lower risk than the stock market as a whole.

And isn’t that what investing is all about? To invest with lower risk?

We all have to invest. It is how we transport the money we hope not to spend today into a future that may include more certain and costly financial demands.

Emphasizing low beta assets allows us to do this time travel with substantially lower risk.