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 (GI