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What Buffett is telling us with his buy of Heinz--and my favorite five "Heinz-like stocks"
02/19/2013 8:30 am EST
Nobody is offering you or me preferred stock yielding 9% in a safe consumer Blue Chip like that Buffett got as part of last week’s $23 billion ($28 billion if you include assumed debt) buyout of HJ Heinz (HNZ.) To get 9%, you have to be Warren Buffett, Sage of Omaha, with a name that brings investment bankers flocking to finance any deal that includes you. (Part of Buffett’s profit from a deal like Heinz is in essence a fee from making the financing of a $28 billion deal easier for his other partners.)
But that doesn’t mean there’s nothing that you and I can learn from a Buffett deal like this. In fact, I think this particular Buffett deal is very educational. The Heinz buyout is confirmation, in case you needed it after looking at other recent Buffett deals like his buyout of railroad Burlington Northern, that he believes in what Pimco bond guru Bill Gross has called “the new normal market” and that I’ve called “the paranormal market.”
The Heinz deal makes the most sense if you see the next decade offering relatively modest returns. The new normal and the paranormal paradigms call for, at best, 5% annually from equities. And a continuation of the high volatility of recent markets. In the paranormal market I point to the extreme volatility of 2011 as something we can expect with frequency. For a description of the new normal and the paranormal paradigms see my posts http://jubakpicks.com/ and http://jubakpicks.com/
Why do I put the Heinz deal in this camp? Because it’s not the kind of value deal most investors still associate with Buffett—although frankly it’s been a long time since Buffett has been a pure value investor. And because what Buffett is paying up for—what he thinks deserves a premium—is the kind of steady, predictable, somewhat better than 5% a year earnings growth that will be hard to find in the new normal and will be all the more valuable for that.
Look at a few numbers on Heinz. For the last five years earnings growth has averaged 7.1% a year. For the next five years the Wall Street consensus puts earnings growth at 7% a year. The stock pays a dividend of 2.83% a year and shows an annual dividend growth rate of 6.3% a year.
And for this Buffett and his co-investor, Brazilian buyout fund 3G Capital, have offered to pay 20 times projected earnings.
This is value? Well, yes, if you define value for a new normal/paranormal period. According to research by Andrea Frazzini and Lasse Pedersen at money management company AQR, Heinz is one of the least volatile big stocks of the last 10 years. The beta on Heinz is a piddling 0.58%, which means that it moves up and down less than the market as a whole. (By definition the beta of the market as a whole is 1.) Despite that lack of volatility—or in the current period I should say because of it—Heinz has posted an annual total return of 9.4% over the last 10 years. That beats the 6.8% annual return on the Standard & Poor’s 500—and the 7.2% annual return for shares of Buffett’s Berkshire Hathaway (BRK.A and BRK.B.)
What Buffett is buying—what he’s willing to pay up for—is that solid, above market return and what looks like an absolutely predictable cash flow. (And a steady cash flow is essential if you own 9% preferred stock. There has to be money to pay out that dividend, even if it is preferred.) After all, even if the stock market tumbles and the economy stumbles, people will buy catsup and baked beans, right?
The price of the deal—what Buffett is willing to pay for this predictability and this shelter from market and economic volatility—makes more sense once you start looking for other “Heinz-like” stocks. There just aren’t that many candidates.
Especially if you eliminate those that Buffett already owns such as IBM (IBM), Procter & Gamble (PG), and Coca Cola (KO). IBM shows 15.5% annual earnings growth over the last five years and a consensus projection for 9.5% growth over the next five. The dividend is 1.7% and the annual dividend growth rate over the last five years has been 16.3%. Coca Cola shows 8% annual earnings growth over the last five years and a projected 8.8% earnings growth rate over the next five. The dividend is 2.7% and the dividend growth rate is 8.45% a year over the last five years. Procter & Gamble shows a 4.7% annual earnings growth rate in the last five years and a projected annual growth rate of 8.4% over the next five years. The dividend is 2.9% and the annual dividend growth rate has been 9.9% over the past five years.
These numbers look very similar to those for Heinz.
And who else?
McDonald’s (MCD) with 15% annual earnings growth over the last five years and a projected 9.8% annual earnings growth for the next five. Dividend yield is 3.3% and the annual dividend growth rate over the last five years has been 13.9% a year. The stock is likely to be more volatile than a Buffett might like over the next quarter or two as the company laps some tough growth comparisons, but after that it would seem to be a good candidate for the club. (McDonald’s is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ )
DaVita HealthCare Partners (DVA) is a potential “Heinz-like” stock. The kidney dialysis market is growing at an almost certain 4% a year as more and more of the U.S. population develops diabetes. The company’s earnings growth rate over the last five years is an annual 15.1% and the consensus annual growth rate for the next five years is 12.7%. The stock does not pay a dividend. Buffett has been accumulating shares of DaVita at a steady pace in recent quarters and I’d call this one a potential “Heinz-like” stock in the making. Although the shares trade at just 15.5 times projected earnings, I’d still be cautious on DaVita over the next few months. DaVita gets much of its reimbursement for dialysis services from the Federal government (66% of revenue comes from Medicare and Medicaid) and payment rates are definitely at risk if the threatened budget sequester goes into force. (Rates for bundled services that include dialysis and a diabetes drug took a cut in the fiscal cliff settlement.) There is the possibility that DaVita will show a miss in the next quarter or two as the company’s ability to cut costs in order to preserve margins lags changes in government policy. (Any miss would likely be a short-term problem; DaVita has a history of effectively cutting costs to preserve margins and its size gives the company substantial bargaining power with suppliers.
Abbott Laboratories (ABT), another Jubak’s Picks http://jubakpicks.com/, is tough to put numbers on after the January breakup of the company. But the Abbott Laboratories piece picked up much of the company’s predictable high-growth businesses—such as the fast-growing nutritionals unit where sales grew 8% in 2012. If the new company can deliver the cost reductions and margin increases that Wall Street expects—a roughly 5-percentage point improvement in margins by 2016—then this will fulfill its promise and become a “Heinz-like” stock.
Yum! Brands (YUM) belongs in this group too—if the company can correct the big hit it took to growth in China when suppliers to its KFC chain were found to have sold the company chicken with levels of antibiotics that exceeded government health standards. This has turned into a major marketing debacle for Yum! with Chinese customers questioning the quality of the company’s food and staying away from KFC in droves. The company has projected a 25% drop in same store sales in China in the first quarter—a big problem since China represented 42% of the company’s operating profit in 2012. I think the risk is that Wall Street is still under-estimating how long it will take to restore customer faith in KFC. I’d wait for more information on how sales are trending in the remainder of this quarter and into the spring. But this is certainly a potential “Heinz-like” stock once Yum! Gets past this problem.
My picks for my 5 favorite “Heinz-like” stocks (or potential ‘Heinz-like stocks)? IBM. McDonald’s. DaVita. Abbott Laboratories. Yum! Brands. I think you may have to wait a quarter or so on some of these before you’ve got enough information and the right price to make a buy.
But then we can afford to be more patient that Buffett right now. We don’t have $48 billion in cash demanding to be put to work in something.
Thank goodness for that, right?
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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