Today’s
blockbuster news event was the announcement the Heinz and Kraft would
merge. Bloomberg provides a good,overarching analysis of the deal:
The deal creates a
stable of household names -- everything from Heinz ketchup to Jell-O -- with
revenue of about $28 billion. It also could presage more consolidation in the
U.S. food industry, which is struggling to reignite growth. Buffett and 3G, the
private-equity firm founded by Brazilian billionaire Jorge Paulo Lemann,
previously teamed up to buy Heinz in 2013 and they cut costs, a strategy they
aim to repeat with Kraft.
It’s impossible to argue against the logic of this
deal. Heinz, which, like Kraft, owns
numerous iconic American brands, was taken private a few years ago. Now that private equity has cut costs and
increased the company’s efficiency, the next logical business step is to go
into acquisition mode to increase the company’s product offerings and market
footprint. Not only do Kraft’s product
offerings complement Heinz’s, but the companies can potentially achieve a large
amount of synergy and cost savings from their respective positions as market
leaders in the consumer staples industry.
The deal illustrates why numerous investors still have tremendous
admiration for Buffet’s investing acumen.
Let’s take a look
under Kraft’s financial hood starting with their balance sheet. Asset structure has been remarkably consistent
for the last four years, with total assets fluctuating between $21-$23 billion
and the composition of those assets remaining near constant levels. In 2012 the company added $9.9 billion in
long-term debt. But, using their highest
interest expense and lowest EBITDA readings for the last five years, interest
coverage is still a healthy 4.74. The
current ratio stands at one. While this would
normally create a bit of concern, receivables and inventory levels are firmly
under control, indicating the company is very well managed financially.
Finally, with a large consumer staples company like Kraft, a tighter balance sheet should
be expected.
Kraft’s income
statement shows why this merger has tremendous opportunities. Top line revenue has stalled between
$18.2-$18.6 billion for the last four years.
Their biggest problem is the ease with which consumers can purchase
substitute goods -- an especially prevalent activity when overall wages have
stalled. There have also been some short-term issues. Last year the company had a
huge, 10% drop in their gross margin, which was entirely attributable to a
recalculation of pension liabilities.
Without this loss, EPS would have been 4.82. But with the loss, EPS was $1.74. While the company also had an increase in SGA
expenses, the overall level rose to one more consistent with recent history. Because Kraft and Heinz are in the same
business, the merger should create tremendous cost savings and synergy, leading to margin expansion over the
next 1-3 years.
Finally, free
cash flow to the firm has fluctuated between $1.4 and $2.5 billion for the last
five years giving the company ample
funds to self-fund all of their activities.
And their cash investing needs, which are solely derived from plant,
property and equipment investment, have been very predictable for the last five
years; they’ve fluctuated between $440 and $557 million.
Kraft was a great
company before the merger. It was the
owner of numerous brands that are a staple of the US market. The company managed its assets incredibly
well and literally printed money. Now
with the addition of another major US consumer staple company, the combination
can achieve major cost savings by eliminating duplicative operations and
achieving even larger economies of scale.
