The announcement of Warren Buffett and 3G’s acquisition of Heinz is clearly a landmark for the food industry. At a valuation of approximately 14x EBITDA it has also caught the eye of the financial commentators. A well respected opinion column in a leading financial newspaper [Lex FT 14/2/13] was so negative that it concluded the deal was “not a ketchup stain on your reputation Mr Buffett. It looks more like blood”.

Perhaps this is an interesting moment to contemplate the fundamental value of food companies. Mr Buffett does not have a historic record of overpaying. In fact, he is generally regarded as being able to see fundamental value in companies that others don’t. His investment success is legendary, earning him the mantle the “Sage of Omaha”. I doubt the billionaire investors from Brazil who are partnering him on this deal are investment slouches either.

Yes, the valuation of Heinz is a premium of 20% to its all-time share price high. The EBITDA multiple is in line with the price paid by Kraft for Cadbury. It is, however, quite a bit lower than multiples for other recent mega deals in infant nutrition. However, Buffett et al have no real synergies from the deal to justify a premium. So what do they see which others don’t?


“What do Warren Buffett et al see in Heinz that others don’t?”

I cannot claim to know Mr Buffett or have direct access to his inside thinking. However, as a food industry financial adviser I spend a lot of time talking to people and thinking about valuation. I have believed for some time that the markets fundamentally undervalue the dynamics of the food industry. When set against other industry sectors that are sometimes regarded as more sexy, food companies have a lot going for them. Here are a few perspectives.

The product - consumers are not going to start eating food in a fundamentally different way. We are not going to start popping pills instead. As such it is possible to take a near perpetual view of the underlying industry dynamic. I don’t think this can be said for technology companies, energy companies, healthcare companies, retailers, fashion orientated industries, banks etc.

Growth - food consumption is going to grow in line with global growth. A global food business should therefore demonstrate gradual but predictable and healthy growth. Exposure to Brics and other emerging markets is important. Heinz has been making strong moves in this regard.

Inflation protection - food companies will, in the long term, increase their product prices in line with underlying inflation. Their value will therefore not be eroded over time like a government bond.

Cashflow - food companies are typically highly cash generative. As such their profits flow thought to investors more efficiently than many other businesses. At the end of the day, increase in cash is what will drive valuation.

Leverage - the reliability of the cashflows makes food companies highly leveragable. Currently, the cost of financing long-term borrowings is unbelievably cheap in an historic context. The Heinz deal involves a lot of debt and Mr Buffett is providing a load of fixed yield preference shares. High leverage is appropriate for these type of assets and delivers stronger equity returns.

Brand ownership - strong global brands such as Heinz are rare jewels. They cannot be easily created and give the owner power with the consumer. Yes, there are threats from increased private label penetration, but the evidence from Nielsen data shows that the number-one brands strengthen as private label penetration increases. The secondary brands tend to lose out. I also happen to believe that, in the long term, internet retailing (or rather order processing) will return more power to brand owners who will increasingly have direct relationships with their consumers.

In a world where investment returns on supposedly safe assets like government or corporate bonds are meagre at best with almost no prospect of capital growth, I believe that the global food companies represent a very attractive long-term investment for pensions funds, sovereign wealth funds and even shrewd individuals! Heinz produces an earnings yield at the takeover price of $72.50 (ie after-tax profits for shareholders) of about 4.3%. This measure ignores the potential for capital growth. By contrast, the yield on 2035 UK indexed linked government bonds is negative! Perhaps the stock market will take note?

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