Kraft Foods: Buffett's Commodity Prediction 12 comments
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The recent revelation that Warren Buffet has built a large stake in Kraft Foods (KFT) sent its shares higher as investors clamored for a piece of the action. The nearly 6% increase in the price of Kraft shares since Mr. Buffet's disclosure confirms that the Buffet bandwagon effect is still alive and well. People are still following the value investor's every move, pouncing when the opportunity arises to skim a quick percentage off the frothy top inevitably left in the wake of the battleship Berkshire. However, has the wisdom of crowds failed to reveal a larger, more promising trend predicted by Mr. Buffet?
The actions of the oracle of Omaha would lend to the theory that Kraft shares are undervalued. Indeed, some key ratio's do reveal value in the shares. Kraft's price to book ratio of around 1.76 is attractive, especially considering all of the real and intangible assets not counted in that number. Kraft's dividend yield rests near 3.5% compared to 5-year trailing yield of 2.6%, beating the pants off the T-bill. A forward P/E ratio of 15 is very decent and a fair price for a deep-moat conglomerate like Kraft.
Yet, as any good investor knows, one must also consider what the future looks like for a company.
As of late, Kraft shares have suffered due to shrinking margins, largely brought on by food commodity price inflation. We have all noticed that milk has skyrocketed in price when we stroll by the dairy aisle in our local grocer. Kraft has not only noticed, they have been hurt by the large increases in input prices.
Unfortunately for Kraft, many have speculated that these increases in food commodities prices are just the beginning. China, ethanol, terror, and just about everything under the sun these days seems to be leading to higher food commodity costs, or so the talking heads would lead us to believe.
Yet, here is a man, famed for picking up shares in companies just at the right time, before they rebound as a result of effective management guiding the company out of a mire; here he is, buying shares in a company with massive exposure to food commodity inflation.
Would Warren Buffet buy shares in a company whose margins will continue to erode in the future? Common sense would say no.
Therefore, we can reach a logical conclusion that either commodity prices are near their top in the eyes of America's financial 'golden boy,' or Kraft has some miraculous trick up its sleeve to stave the further melting of its margins like so many sticks of Velveeta in a sun-drenched Volvo.
I am inclined to take the former conclusion as the most likely of the two. Food commodities prices are near an absolute maximum and therefore should begin to descend from their Everest-esque peak in the near term.
This development will prove beneficial for KFT.
For the more risk-seeking, take a look at Wimm-Bill-Dann Foods OJSC (WBD) and Lifeway Foods (LWAY), whose explosive growth has been stalled lately due to high food commodity prices. Should these food commodity prices fall, the shares should take off.
Disclosure: Author holds positions in the above-mentioned securities
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This article has 12 comments:
This mitigates the margin erosion that's priced in to the shares today. Buffet (and anyone else who takes a moment) is smart enough to know that either commodity prices will drop or Kraft will raise prices under cover of overall consumer price inflation. In any case, they aren't just going to grin and bear it until their margins go negative...
Basic consumer staples are a great inflation hedge when the usual hedges (real estate, gold, oil) are probably overpriced heading into crunch time.
Another possible logical conclusion to BRK purchase of Kraft shares: Buffett is wrong and Kraft's moat will not protect it sufficiently from input inflation; that consumers will shift to off label brands; that Kraft will undergo longterm margin compression, that this was not a good purchase for Berkshire.
Basic Consumer staple brands will only protect you if the consumer thinks that the extra quality is worth the extra cost. But lets be honest, I might buy a brand name box of cereal for $5, but not for $8, at which point, (for example) I will switch to a store brand, or off label.
Look what happened to big Pharma---undercut by generics as they come off patent protection, yes, but also this was due to consumers becoming educated that the name brand drug at twice the cost doesn't have twice the benefit of the generic drug. Big Pharma is experiencing margin compression partly due to generic competition.
The analogy with food and drugs is not perfect, obviously, but I don't agree that Kraft will just be able to raise prices to meet the input cost as they rise--they are competing against alot of other brands out there that may lose loyalty when the prices get past a certain point.
A better bet: Big Tobacco, Big Alcohol, and Natural Gas---these are stocks that are much more likely to survive the inflationary period we are entering.
I don't agree on the Pharma parallel (though certainly a big generic drugs producer should also act as a great inflation hedge barring congressional meddling...). Branded consumer staples are vulnerable to "trading down" in tough times, but if the relative gap between premium brands and value brands stays the same in an overall rising price environment, the impact should be muted. Your comment about the $5 cereal vs the $8 cereal illustrates this. In an $8 cereal world, milk would cost $10 a gallon and the median US income would be $65K/year. Everything would stay relatively in line, and brand-buyers would just keep on buying brands.
Of course if food prices rise but wage levels don't, you have a very good point. I just don't think that will happen long-term. And anyway if it does, KFT's share price is low on my list of worries -- at least somewhere below finding a second (or third) job...
It's my opinion that the soft commodity costs will hit the restaurants harder than Kraft; diners will see escalating costs at their restaurants and choose to dine more frequently at home... If that holds true, people would buy more from Kraft… Restaurants would buy less from Sysco and other food vendors. My bottom line: Kraft - Relatively positive outlook; Sysco - Negative Outlook.
From his speech - I never hear him mention anything about this sort of prediction.
Benjamin Graham theory - Like Benjamin, Buffet looks at the average earning over a period of 7-10years and disregard one year of disappointing earning. This is a season factor, not permanent. Kraft fit this profile. If and when the earning returns to its average then share price will rise, if not he has his safety margin.
PetroChina ?
Even after Buffet sold and made profits from PTR. He never mentioned that he had predicted the oil price surge. He says that the company was value at 100billion at the time it was traded at 38billion.
From his speech - I never hear him mention anything about this sort of prediction.
Benjamin Graham theory - Like Benjamin, Buffet looks at the average earning over a period of 7-10years and disregard one year of disappointing earning. This is a season factor, not permanent. Kraft fit this profile. If and when the earning returns to its average then share price will rise, if not he has his safety margin.
PetroChina ?
Even after Buffet sold and made profits from PTR. He never mentioned that he had predicted the oil price surge. He says that the company was value at 100billion at the time it was traded at 38billion.
From his speech - I never hear him mention anything about this sort of prediction.
Benjamin Graham theory - Like Benjamin, Buffet looks at the average earning over a period of 7-10years and disregard one year of disappointing earning. This is a season factor, not permanent. Kraft fit this profile. If and when the earning returns to its average then share price will rise, if not he has his safety margin.
PetroChina ?
Even after Buffet sold and made profits from PTR. He never mentioned that he had predicted the oil price surge. He says that the company was value at 100billion at the time it was traded at 38billion.
From his speech - I never hear him mention anything about this sort of prediction.
Benjamin Graham theory - Like Benjamin, Buffet looks at the average earning over a period of 7-10years and disregard one year of disappointing earning. This is a season factor, not permanent. Kraft fit this profile. If and when the earning returns to its average then share price will rise, if not he has his safety margin.
PetroChina ?
Even after Buffet sold and made profits from PTR. He never mentioned that he had predicted the oil price surge. He says that the company was value at 100billion at the time it was traded at 38billion.
From his speech - I never hear him mention anything about this sort of prediction.
Benjamin Graham theory - Like Benjamin, Buffet looks at the average earning over a period of 7-10years and disregard one year of disappointing earning. This is a season factor, not permanent. Kraft fit this profile. If and when the earning returns to its average then share price will rise, if not he has his safety margin.
PetroChina ?
Even after Buffet sold and made profits from PTR. He never mentioned that he had predicted the oil price surge. He says that the company was value at 100billion at the time it was traded at 38billion.