3G Capital’s symbiotic relationship with Warren Buffett is well known–3G needs Warren Buffett’s patronage in order to gobble up the leading consumer brands in the United States, and Warren Buffett needs 3G because of his temperamental, or at least reputational, unsuitability for being directly associated with terminating the employment of thousands. We are finally getting our first peek at what the launching point for the Kraft-Heinz food conglomerate looks like, with the immediate profile being this: Kraft-Heinz pumps out $3.3 billion in profits per year and makes an average of 11.9% on every Heinz ketchup, Philadelphia cream cheese, Maxwell House coffee, Kraft cheese, Planters peanut, Oscar Mayer hot dog, and Velveeta macaroni and cheese sold.
Under previous management, this would warrant a valuation of about 20x earnings for a combined conglomerate value of $66 billion. At a current price of $72, the market cap is $86 billion. The current price would imply a 20% to 25% premium over what you would expect based on fundamentals alone assuming neutrally talented management.
But management is not neutrally talented when it comes to raising earnings. At Anheuser-Busch, the profits of $2.50 grew in 2010 to $5.25 in 2015 (not including any costs or benefits associated with the SABMiller acquisition.) This was driven by improving per item profit margins from 8.2% to 18.6%. If Kraft-Heinz experiences similar per item profit improvement, it is not inconceivable that the profit margin could enter the 20% territory by 2020.
If the profit growth at Anheuser-Busch is loosely reflective of what will happen at Kraft-Heinz, then profits of $2.75 per share in 2015 will be $5.77. When I try to value the 3G effect on Kraft Heinz, I come up with something like this: “Are you interested in owning a food giant that will be generating $5.77 per share in 2020 and should be fairly valued around $115 per share then? You also get to collect a dividend of over 3% that should grow each year while you wait.” If that interests you, Kraft-Heinz would be a worthwhile investment.
I also think Kraft-Heinz has the potential to act as a food industry consolidator. The primary focus at Kraft-Heinz right now is cutting costs and reducing debt. The debt burden is over $24 billion. Some of it is high interest debt to Warren Buffett that will be paid off through refinancing in the next year. For a food company making over $3 billion, that is unusually high.
On the other hand, there is also the possibility that Kraft Heinz is only three to five years away from its next big acquisition. If it gets profits up to over $5 billion, and reduces debt from $24 billion to under $20 billion, it would suddenly find itself around the industry average. At this point, I would expect one of two moves: (1) the company gets purchased at a premium and folded into Berkshire Hathaway in entirety and serves as another subsidiary, or (2) the company looks to make another acquisition and repeat the process with Kellogg or Mondelez.
The dividend future for Kraft-Heinz is also quite bright. Although the dividend growth is slow at first–the recent 4.5% hike in the quarterly payout from $0.55 to $0.575 seems to confirm that–3G does have a habit of passing on profit gains directly on to shareholders. Anheuser-Busch grew its dividend from $1.18 in 2011 to $3.80 in 2015. That is extraordinary dividend growth for a stodgy food or beverage company.
Although predicting the “when” or the exact amount is more art than science, I think it is fair to conclude that Kraft-Heinz will be paying out a significantly higher dividend in 2020 compared to the initial annualized rate of $2.20 at the time of the combined entity. It is not out of the realm of possibility to see someone who bought Kraft-Heinz in 2025 to be collecting $5 per share in dividends five years from now, for a yield-on-cost in the range of 7%. That is something you only see for investors that buy stock during recessions; it is very unusual for a large food company to do this based on improving fundamentals rather than the investor getting the right price at the start.
Almost every analyst is currently panning the price of Kraft-Heinz as too pricey. I’m not there yet. I think paying around $70 per share in 2015 is a fair shake compared to the earnings you’ll see Kraft-Heinz paying out five years from now. There is also the possibility of being dividend increases ahead. If you hold this in a retirement account and reinvest, you should be pleased.