- Although Buffett's elephant gun is close to reloaded, it's unlikely he'll be firing at these two companies.
- At first glance, both look to be right up Buffett's alley when it comes to simple cash flow generative businesses.
- But they both operate in businesses that appear to be in fundamental decline.
Two Stocks Warren Buffett Won't Buy
Warren Buffett and 3G are a few years removed from their Heinz buyout, which was right at $23 billion. This partnership to buy Heinz has signaled a new wave of consumer goods M&A in what used to be uncharted waters of $15 billion plus deals.
A number of big-name food companies have been on watch. And with Buffett noting that his cash pile is rising month to month, his elephant gun is close to reloaded. Buffett likes simple businesses with a record of generating positive earnings.
Two companies that fit that bill on the surface are Kellogg (NYSE:K) and Campbell Soup (NYSE:CPB). And both have brands with staying power; likely to be around for another hundred years or so. However, after a deeper dive, it looks like getting Buffett to buy either company is more of a pipe dream.
Campbell: Is soup "dead money"?
Forbes highlighted Campbell as a potential Buffett target. The news site/magazine noted that the highly negative attitude of Wall Street toward Campbell is a positive, going as far as to say that the negativity in itself could trigger takeover talk. Campbell Soup has been around for more than a century as the world's largest processor and marketer of packaged soups. The one intriguing factor that could make Campbel appealing to Buffett is that the company could be primed for cost cuts and international expansion.
However, the soup business continues to be weak, and soup still makes up 30% of sales. Consumers will likely continue to shift away from simple meals and move toward fresh meals, which are healthier. Campbell isn't doing much to change the perception of soup either. Since 2012, Campbell has dropped its ad spending (as a percent of revenues) by 150 basis points.
Campbell's organic growth is less than exciting. Over the last three years, its organic growth has barely managed 1%, versus its internal target of 3% to 4%. And its gross margin, compared to peers, has been in decline. Assuming it uses packaged foods acquisitions (read: more Plum Organics-like acquisitions) to drive growth, that'll likely drive margins even lower. The company's gross margin was 40% in 2011, and it's now down to around 35%.
As far as a buyout, there's also the headwind of the Dorrance family owning almost half of the company's stock. And they don't look to be sellers.
Kellogg: Good company, bad product?
Kellogg was brought up as a Buffett buyout target earlier this year. There's no denying Kellogg's dominant market share. Kellogg owns 27% of the cold cereal market, and General Mills (NYSE:GIS) owns another 27%. But being a leader in a declining industry is like being the best house in a bad neighborhood. Your housing value is going to get drug down by the neighborhood.
Kellogg might be a great company, but its products are quickly falling out of favor. The cereal business is in decline. Charlie Munger has historically compared cereal to the airlines, where prices can be irrational. And given the price sensitivity of cereal buyers, low prices by one cereal maker means bad news for the entire industry.
Post (NYSE:POST) is another company highly levered to cereal business, and it's been doing everything possible to reduce its reliance on cereal. Still, it's a perpetual underperformer year to date. As well, both Kellogg and General Mills have underperformed the market of the trailing twelve months.
Kellogg: Just not enough upside in cereal
Then there's the rise of various other breakfast options, including Greek yogurt and the likes of Taco Bell's introduction of breakfast. More specifically, yogurt has quickly moved into second, behind cold cereals, as the largest breakfast category in the U.S. It remains the fastest growing area of breakfast foods. And as consumers turn toward a more healthy lifestyle, sugary cereals will continue to fall out of favor. Cold cereal consumption has declined by 1% annually over the last 10 years.
Unlike Campbell, Kellogg has been spending to advertise and counter the trend. It's pushing protein packed cereals, especially when paired with milk. However, it's not only battling the decline in cereal consumption, but also milk consumption. WhiteWave's (NYSE:WWAV) success has been a testament to the decline in milk.
Then there's Kellogg's attempt to paint yogurt in a negative light, which may well push some customers away from Kellogg all together - where they disapprove of Kellogg's marketing tactics. Kellogg is no stranger to overexerting the benefits of its cereal, with past bans on their Special K ads and Rice Krispies ads.
On the positive side, Kellogg could be a candidate for cutting costs, which would be appealing for Berkshire. And in the current (euphoria-like) M&A environment, it could be a takeout candidate by other food companies. PepsiCo (NYSE:PEP) has been touted in the past as a potential acquirer, giving the company a stronger presence in breakfast, and pairing nicely with its Quaker brand.
It could also use an acquisition to deter activist Nelson Peltz's Train Partners from pursuing a breakup of the company's beverage and foods business. But if Buffett wouldn't buy Kellogg, why would PepsiCo?
Campbell & Kellogg: Valuation presents another headwind
Both Kellogg and Campbell trade at an EV/EBITDA multiple of 12x, suggesting that with a buyout premium, the valuations of these two stocks will be high.
Some of the most recent deals include ConAgra (NYSE:CAG) buying up Ralcorp at a 11.9x EV/EBITDA multiple, Nestle buying Kraft's frozen pizza business for 12.5x, and Kraft buying DANONE's biscuit business for 13.2x.
The 5-year earnings per share annualized growth rate for Campbell and Kellogg have underperformed their major peers. However, both still trade above the average food group EV/EBITDA, which is just around 10.5x.
With that said, the Heinz deal was done at a near 15x EV/EBITDA and looked expensive at the time. It's proven to be a great deal.
Campbell Soup's free cash flow yield of 4% makes it a less-than ideal buyout candidate. However, Kellogg's 8% is much more enticing, if not for the nature of its business. Either ConAgra or Kraft Foods (NASDAQ:KRFT) would also be intriguing, given their 8% plus free cash flow yields.
However, the debt levels likely make ConAgra and Kraft unappealing. A couple stocks with more than manageable debt levels include Hershey (NYSE:HSY) and J.M. Suckers (NYSE:SJM), but their free cash flow yields, 5% and 3.4% respectively, just don't cut mustard.
Overall, Kellogg and Campbell don't look like they'll be bought up by Berkshire anytime soon, but investors will still get a decent dividend from either, both yielding 2.8%. Again just don't buy either with the hope they'll be bought by Buffett, or with the hope of seeing market-beating stock appreciation over the next few years.