I’ve gotten a few questions about Jason Williams’ free Wealth Daily article on Friday that hinted at “Warren Buffett’s Next Target,” so I thought we’d take a moment to throw those clues into the ol’ Thinkolator for you.
There is a cottage industry on Wall Street right now that really demonstrates the short-termism of the markets: No longer are we talking about the “next Warren Buffett” or whether or not we can identify the “next Berkshire Hathaway” to build long-term wealth with a “one decision” investment… now we’re trying desperately to identify the next company that will be acquired by Warren Buffett, in hopes that the shares will pop in a hurry if we guess right.
Though, to be fair, most of the speculation revolves not around Buffett, who tends to be the background partner and the financier, but the activist acquirers who Buffett has been inclined to partner with, 3G Capital. After 3G and Berkshire collaborated on the Kraft/Heinz merger a couple years ago, and were rebuffed recently in their first overtures to Unilever, everyone’s trying to figure out where 3G will go next — and, with Buffett’s billions available for financing deals, there’s almost no limit (Unilever is a $150 billion global conglomerate, and it would have been a big bite for the smaller $110 billion Kraft Heinz, but no one really doubted that they could do it if Unilever was willing and 3G and Berkshire were on the deal).
That’s not to say Berkshire isn’t happy to be an acquirer, though they don’t generally prefer to take the lead on highly public takeovers of public companies — Buffett’s preference is either to be a financier with good terms (like preferred shares or warrants), or to acquire private companies in near-handshake deals without an auction process. There are exceptions, like Berkshire’s gradual takeover of Burlington Northern a decade ago and their takeover of Precision Castparts in 2015, both of which were public companies that Berkshire acquired by paying a significant premium, but, generally speaking, when folks talk about the next big acquisition from Berkshire these days they’re really looking for the next opportunity Berkshire has to finance another big, levered deal run by 3G Capital.
With good reason — 3G Capital is not terribly popular, largely because they are focused on efficiency and their takeovers end up leading to a lot of cost cutting, but they have had some incredible success with cost cutting and turnarounds and M&A at Anheuser Busch, Burger King/Tim Hortons, Kraft Heinz and elsewhere… and Berkshire has already enjoyed a nice boost from its large stake in Kraft Heinz.
That cost cutting generally means a lot of layoffs and plant or office closures, and they have a high enough profile as corporate raiders that there are even questions at the Berkshire Hathaway annual meeting each year about whether Berkshire should really be working with these kinds of rapid-downsizing investors. Buffett has responded with laudatory words about 3G’s success in growing businesses, and has generally noted, in his typically folksy way, that “I don’t know of any company that has a policy that says we’re going to have a lot more people than we need.”
With 3G running the show, Buffett gets to be part of an aggressive takeover team that works with companies that are big enough to move the needle for the giant Berkshire portfolio… but he also gets to be a passive partner, without controlling the company or signing the layoff notices. It’s a fine line to walk, because part of what makes Berkshire appealing as an acquirer of either public or private companies is that they are extremely decentralized and hands-off, and allow management to keep running things (part of the rationale for acquiring Precision Castparts and Burlington Northern, for example, was that management would stay and would remain in charge, but would become better able to run the business without the pressure of public shareholders)… definitely not the way 3G works with public companies. But, so far, it works.
That’s quite enough preamble, right? What’s the company being teased here? This is how Jason Williams fires up our imagination:
“I’ve found his next potential target. It’s a by-the-book value investment. It’s in a perfect place to make shareholders a ton of money and to be bought out by the Oracle of Omaha as he tries to capture its gigantic share of the market.”
So what is this “by the book value investment?” We get a few clues:
“It’s trading at a 41% discount to its peers on a price-to-earnings basis. And its enterprise value to future EBITDA (earnings before interest, taxes, depreciation, and amortization) — my favorite valuation metric — is substantially lower than the rest of the industry, too.
“It makes products that consumers buy no matter what the economic outlook is. When times are tough, people want these goods. When times are good, people want even more.”
We’re told that it’s trading “at the top of its historical level,” which probably means that it has a high PE ratio relative to its own historical valuation, and it sells necessities and “is best known or its dominance in the consumer goods sector.”
What else do we learn? Total sales were something like $17.6 billion in their last fiscal year, with no more than 20% of that total coming from any one segment. It grew revenues each quarter last year, and adjusted diluted earnings per share went from $2.56 in 2012 to $2.92 in 2016.
Other clues? More than 100 years old, 24 years of dividends, 13 years of dividend growth, and earnings and operating cash flow growth of 3-4% per year.
And, according to Williams, it’s an appealing takeover target:
“It’s got some debt, but not too much, and its coverage ratios are outstanding. There’s enough cash in the bank to cover the quarterly dividend payment more than five times over. And the annual operating cash flow (CFO) covers the interest payments on the outstanding debt plus some. In fact, the CFO is about 900% of the annual interest payment. That’s low debt with lots of cash to cover it and then some.
“The supremely discounted valuation makes Buffett’s next target a likely takeover candidate, too. You already know it’s trading at a 41% discount to the rest of its peers from a price-to-earnings standpoint. But its enterprise value (takeover value) is discounted, too. It’s a good 6% cheaper than any of the other companies in the industry.”
So what’s the stock being pitched here? This is, sez the Thinkolator, the old standby “consumer staples” company General Mills (GIS).
General Mills started out as, well, a mill almost 150 years ago, and they still sell the Gold Medal flour that got it all going… but they’re mostly known for their cereals and other packaged foods, from Cheerios and Wheaties and Yoplait yogurt to Haagen Dazs and Pillsbury and Progresso. They have not been completely left behind in the move to organic and natural foods, they acquired organic Mac & Cheese queen Annie’s a few years ago to go with other brands like Cascadian Farms and Muir Glen, but the story is still really largely driven by Cheerios and Pillsbury and some very old and established grocery aisle brands.
And really, for a while the story at General Mills could be oversimplified to be the story of rising Yoplait and falling Cheerios and Wheaties sales — traditional cold breakfast cereal has been gradually slumping for a decade or more as that segment experiences a long, slow decline, so although it still generates a huge amount of sales and is quite profitable, it’s not going to help them grow the business… growth was coming from Yoplait, from tex-mix foods like their Old El Paso brands, their snack food brands, and Annie’s. But then, last year, the impact of greek yogurt on Yoplait seemed to really finally hit for General Mills — GIS underestimated greek yogurt a decade ago, and, despite introducing greek variations of Yoplait over the years, never really managed to outmaneuver Chobani and the other upstarts, and they had a pretty shockingly bad sales decline last Summer. That happened to come right after the stock had soared on the “buy consumer staples at any cost” panic trade that had folks clamoring for old, familiar stocks with decent dividend yields, so it was an unusual several month period when GIS climbed 15% or so and then collapsed by 20% in a hurry.
That hasn’t generally happened very often with General Mills — people buy stocks like these for stability, and even during the financial crisis crash GIS shares only fell from a high of $33 to a low of about $25, a 25% drop at a time when the broad market was falling by 45% (and GIS was back in the black by the end of 2009, more than a year before the market reached it’s pre-crash levels). This year, it’s not so much working that way yet — General Mills revenues have continued to gradually decline, though they have managed to turn that declining revenue into earnings growth by becoming more efficient and focusing more on their growth brands (and buying back shares).
Does that make this an appealing target for 3G? I don’t know. It’s possible — their last target, Unilever, is also a pretty stagnant company in terms of revenue, and 3G is not a growth focused investor, they’re very much focused on buying strong operating companies on the cheap and making them more profitable. That could fit for GIS, though I don’t really know what kind of efficiency opportunities might be available for the company — they have not grown significantly more profitable over the years, both their profit margin and their gross profit margin are just about average compared to their last decade or so of operations.
GIS is a little bit cheaper than most of their peers on most valuation metrics, perhaps because of that consistent decline in revenue and the perception that revenues will continue to fall for at least the next year or two (though many packaged food and cereal companies ought to be in similar straits — Kellogg, for example, is expected to have flat sales for the next three years, and they’re probably worse than General Mills when it comes to overdependence on the weak cereal market).
So… General Mills is valued at a discount to its “blue chip” packaged food peers, it has been fairly stable, with earnings and dividend growth, despite their lack of top-line revenue growth and some substantial long-term challenges in some of their biggest product lines. It has a good balance sheet, it looks like they’ve taken on some debt to buy back shares but the debt position is quite small, and their brands and operations obviously have some enduring value even if they’re not currently growing.
That’s a decent pitch for 3G, perhaps, though it doesn’t necessarily mean that 3G will jump on General Mills. When I look at the shares, I see that it’s probably just about fair at this price — probably investors are overpaying for the level of growth they’re getting, but that’s true for most brand-name consumer staples companies right now. For patient investors, it might work out fine if they can continue to expand the Annie’s organic line and “fix” Yoplait, or if anyone can figure out how to get millennials to start buying cereal, but it’s unlikely to keep up with the market if stocks keep percolating higher. On the plus side, it’s probably not going to fall as hard as the market if we get a nasty crash or a bear market, and, in case your memory doesn’t go back more than seven or eight years, those do tend to come along from time to time. I’m not interested in General Mills at this price, personally, but… well, it’s your money, so you can make your own call. If 3G does indeed move to have Kraft Heinz acquire General Mills (or some other packaged food company), I’ll settle for being part of Buffett’s financing as a Berkshire Hathaway shareholder… I’m sure he’ll get a better deal than I could.
P.S. The ad and the link to their signup pitch also reference their “Internet Royalties” stock that has given them gains of “an amazing 183%” at The Wealth Advisory… that ad has been around since the Fall of 2014, and it’s still pitching Coresite (COR) as a leading data center REIT investment. It has indeed been successful for them, as it has been for me and many Gumshoe readers (this one caught my eye as a compelling buy back in 2010, though I didn’t get around to buying it personally until late 2013), but it’s not a magical “royalty” or anything like that. It’s just a REIT that owns data centers and has had phenomenal dividend growth — it had an almost-4% forward yield at $13 in the Fall of 2010, at $13 a share, and today has a 3.6% forward yield at $88 a share… so sometimes you can get extremely fortunate and enjoy solid dividends and 500%+ capital gains. My future hopes for that one are much more limited, but it’s still a top-ten position in my Real Money Portfolio and I write about it with some regularity.