Right now, shares of Kraft-Heinz trade at $71 per share. The dividend yield sits at 3%. For a food conglomerate that has spent the past fifteen years growing revenues at 3%, you might ordinarily expect to generate 8% long-term returns according to the following assumptions: (1) you pay fair value for the company, (2) the 3% annual revenue growth translates into 5% earnings per share growth, and (3) you collect the dividends as cash rather than choose to reinvest.
What makes Kraft-Heinz especially intriguing right now is that second element: how revenue growth translates into earnings growth.
Peter Brabeck-Lemanthe, the Chairman of Nestle, provided a telling a quote on how the 3G management team is quite different from ordinary corporate management: “3G and Warren Buffett have pulverized the food industry market, particularly in America with serial acquisitions. 3G’s partners are known in our industry for ruthless cost-cutting and have already proven numerous times that they are capable of reducing operating costs in particular by between 500 and 800 basis points, which has a revolutionary impact on all the other members of the industry.”
The characteristics of Anheuser-Busch during 3G’s stewardship period gives us a hint of what to expect at Kraft-Heinz. Look at what happened between 2011 and 2012 when Anheuser-Busch’s revenues barely budged from $39 billion to $39.7 billion. Although the revenues barely budged, earnings shot up from $3.63 to $4.45.
The past two years have revealed similar results. Revenues have grown from $43 billion to $46 billion, for a cumulative gain of 7%. And yet, earnings have grown from $4.81 to $5.65 over that same time frame, for a cumulative gain of 17.5%. This ability to deliver outsized earnings growth partially explains why Anheuser-Busch’s stock price has tripled in the past five years (the other explanatory reason is that the P/E ratio has expanded over that time from 15x earnings to 20x earnings.)
The drawback executing this strategy is that it tends to deplete employee morale and make it difficult to recruit outstanding talent. The brands, however, tend to sell themselves–selling Budweiser or Philadelphia Cream Cheese is something that happens every year without top-shelf human capital selling the goods.
I anticipate that earnings per share at Kraft Heinz will shoot through the roof between 2015 and 2018 as costs are lowered, and sometime between 2018 and 2022, you will see either (1) a significant acquisition that can be bolted on and permit 3G to duplicate the process all over again or (2) Berkshire Hathaway acquire the company outright. In a CNBC interview, Warren Buffett said that Kraft Heinz is something he hopes will always be part of Berkshire’s stable–which should tell us something about the timeless demand for ketchup and cream cheese, as well as offer a hint of Berkshire’s eventual desire to buy out 3G and the public shareholders.
Normally, I wouldn’t be especially enthusiastic about paying 20x earnings for a high-quality food quality. But the new management team ought to send earnings per share quite higher in the next 3-5 years, and plus, there is the reasonable chance of another big acquisition or buyout looming on the medium-term horizon. The medium-term looks quite bright for shareholders of Kraft-Heinz, as I estimate total returns in the 10-12% annualized ballpark over that time frame. For a company of such high quality, those are risk-adjusted returns that should catch your eye.
Originally posted 2015-09-10 14:29:07.
