A mountain of debt affects Kraft Heinz – This is damaged – Kraft Heinz Company (NASDAQ: KHC)

A few weeks ago, I wrote an article as a direct feedback to an argument Warren Buffett did, and essentially dispute the idea that Kraft Heinz (KHC) is a wonderful business. Towards the end of the article, I issued a $ 54.6 billion business value assessment program, even under what I considered a very optimistic assessment of future business performance. When I reflected on this course goal, I realized that I had over-simplified the differences between debt and equity, and I would like to take a deeper dive into the capital structure of the company and further refine my valuation framework.

Debt Is Cheap But Risky

At the end of 2018, Kraft Heinz had almost $ 31 billion in long-term debt, an increase of $ 2.5 billion from the previous year, and paid about $ 1.3 billion in interest on That, a speed of approx. 4%. At the time of writing, the company has a market value of around $ 40 billion, which means that debt now amounts to almost the same amount of the pie as equity. In my article explaining my valuation method, I require a minimum return of 10% on an equity I am interested in buying, making 4% debt much cheaper. However, this also means that repayment of the debt is a costly affair, since the money offered in this way only bears a 4% return on the investment. Contrary to retained earnings being reinvested into the core business of 71%, or even as opposed to shareholder returns, with an earnings yield of 8.6%, termination of debt gives poor returns.

Although debt is currently very cheap and thus yields poor returns, it is the risk that must be considered. The shareholders' return of 8.6% will not make the shareholder a good sum if the business goes bankrupt or the income otherwise deteriorates so that it increases 8.6% over time before the business has paid enough to have made a worthy investment. With $ 1.3 billion in interest rates of about $ 6 billion in revenue, interest rates eat a large portion of the cake. Of course, 42% of the capital structure is tied up in debt, and it uses only 22% of the cake, which is a win. The risk is, however, that a slight decrease in operating revenues will have a greater influence on the shareholder's bottom line due to fixed interest expenses.