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A bitter result: 3G's rigorous cost-cutting diet weighs down RBI, Kraft Heinz

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Thursday, April 19, 2018 – Page B1

There's no doubt about it: Tough, cost-conscious management is a vital ingredient at any good company. But right now, shareholders in Restaurant Brands International Inc. and Kraft Heinz Co. should be asking whether a lean and mean operating style is hitting its limits when it comes to peddling doughnuts and ketchup.

In recent months, RBI, the parent of Tim Hortons, and Kraft Heinz, maker of your favourite burger condiment, have disappointed investors. RBI shares have lost nearly 20 per cent of their value since October, while Kraft Heinz's stock price has slid by a third over the past year.

It wasn't supposed to be this way.

3G Capital, the famed and feared Brazilian investment firm, was a driving force behind the assembly of both companies. Only a couple of years ago, the guys from Rio were being lauded by analysts for their ability to slash costs and trim corporate fat - precisely what was needed to squeeze new profits from aging consumer brands, according to Wall Street.

But the 3G approach is beginning to show some flaws. Critics argue that managers who focus on streamlining existing operations can create a temporary bump in earnings, but have less time to spend on product development, corporate innovation and brand building. The danger, skeptics say, is that efficiency increases but sales and earnings per share don't.

"We harbor serious doubts about the management team's ability to generate sufficient product innovation to grow its collection of 'retro' brands in highly commoditized categories," Robert Moskow of Credit Suisse wrote this week in a report that downgraded Kraft Heinz to "underperform" status.

For its part, RBI is battling a group of Tim Hortons franchisees who claim the company is waging its war on costs at the expense of restaurant owners' profit. It's also being investigated by the federal government for alleged breaches of the promises it made when it acquired the doughnut chain in 2014.

To be sure, most analysts continue to offer glowing appraisals of both RBI and Kraft Heinz, in large part because of the success of the 3G model in cutting costs. After the company teamed up with Warren Buffett to buy Heinz in 2013, profit margins rocketed over the next two years. At RBI, which 3G created by merging Tim Hortons with Burger King, it has managed to propel return on equity to nearly 32 per cent, a remarkably high level by fast-food standards.

But softer measures suggest the profit is coming at a cost. Consider a survey of 1,501 Canadian adults published this week by Angus Reid Institute.

Thirty five per cent of respondents said their opinion of Tim Hortons had worsened in recent years. While Tim Hortons' advertising campaigns have tirelessly promoted the chain's deep roots in Canadian communities, the reality on the ground appears to be shifting.

At Kraft Heinz, signs of stress are also becoming apparent, according to Mr. Moskow. The company's Oscar Mayer cold cuts and Kraft natural cheese brands are losing market share to private labels, while Canadian retailers recently reduced their inventories, he said.

Employees may not be all that happy, either. Mr. Moskow said industry sources have expressed concern about growing turnover rates among Kraft Heinz staffers.

"We find it quite telling that the company chose not to publish its turnover rate in its February 2018 presentation called Recruit, Develop and Align our People," he wrote.

When asked for comment, a company spokesman said, "At Kraft Heinz, we are a company of owners that thrive in a performance-driven environment - and we invest heavily to develop our employees."

Of course, the recent weakness in RBI and Kraft Heinz shares could be transient.

But investors who want to take a long-term view should consider the case of AnheuserBusch InBev SA, which some of the principals of 3G were instrumental in building.

The beer giant assumed its current shape in 2008, after InBev, a Brazilian-Belgian brewer, took over the U.S. firm Anheuser-Busch.

A rigorous diet of cost cutting produced great results for investors over the next few years. Since 2013, however, the stock has lagged the S&P 500 by about 9 percentage points a year of total return and the company has turned to acquisitions to drive revenue growth.

For now, wary investors may want to keep their distance from RBI and Kraft Heinz.

"The 3G business model is very good at cutting non-essential overhead, focusing on price realization, and running an efficient plant and distribution network," Mr. Moskow said. "However, its ability to drive sales growth through marketing, new products, and strategic investment has yet to be proven."


CLOSE: $69.53, UP $1.27 KRAFT HEINZ (KHC)

CLOSE: US$60.79, DOWN 90¢

Associated Graphic

RBI, which 3G created by merging Tim Hortons with Burger King, has seen its shares drop nearly 20 per cent since October, while Kraft Heinz's stock price has slid by a third over the past year. DANIEL BECERRIL/REUTERS

Pastries are displayed at a Tim Hortons during a media event in Mexico in October, 2017. While its parent company has generated a nearly 32-per-cent return on equity, the reality on the ground appears to be shifting against the Tims brand. DANIEL BECERRIL/REUTERS

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