An Investment Idea for Warren Buffett´s Sweet Tooth

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Warren Buffett is famous for investing in simple, stable companies with strong and durable competitive advantages, and the food and drinks industry can be a very fertile ground when it comes to looking for those kinds of investing opportunities.

Well known brands coupled with easy to understand business models and high returns on invested capital make a mouthwatering combination, so it’s no wonder at all that the Oracle of Omaha has been traditionally inclined towards the industry.

A Sweet Tooth

The biggest position in Berkshire Hathaway´s (NYSE: BRK-A) (NYSE: BRK-B) portfolio is no other than Coca Cola (NYSE: KO) , the most popular brand in the global drinks industry, actually the most valuable brand in the world according to Interbrand. Not only that, the company has built an unparalleled distribution network which would be practically impossible to replicate by any competitor, so it´s the quintessential example of a simple business model with indestructible competitive advantages.

Coke charges for a soda bottle nearly two times the price of generic competitors, and it has scale advantages on the cost side too. This means that the company produces extraordinary profitability, and Berkshire Hathaway has been enormously benefited by growing dividends and a rising stock price from its Coca-Cola holdings since 1988.

Berkshire´s latest acquisition Heinz (NYSE: HNZ) has many things in common with Coca-Cola. The Heinz brand has an undisputed leadership in the ketchup segment, and the company owns other 15 brands in businesses like sauces, soups, baked beans, baby food, and frozen foods which generate more than $100 million in annual sales each.

The Heinz deal was quite particular from the financial point of view: Berkshire got preferred shares with a delicious dividend yield of 9% in addition to common stock and warrants. But Heinz still fits quite well into Buffett´s investment logic, a low risk business with strong competitive advantages and return on equity well above 30%.

Buffett has always been fond of high quality names in the food and drinks business; he acquired See’s Candies in 1972, Dairy Queen in 1998 and he bought an 8% of Kraft Food, now Mondelēz International – the owner of Oreo cookies and Cadbury chocolate among others - in 2008. There is a clear pattern here, and there is no reason to believe that the investing superstar will lose his appetite for high quality companies in the food business any time soon.

A Chocolate Maker for Dessert

Hershey (NYSE: HSY) is the leading player in the US chocolate market, the company owns a product portfolio consisting of more than 80 brands including Hershey's, Reese's, Kit Kat, Twizzlers, and Ice Breakers among others.

 

<img alt="" src="http://g.fool.com/editorial/images/20919/brands_large.jpg" />

The company derives nearly 85% of sales from the US market where it has a dominant market share above 43%, but it has been working on joint ventures and increasing its advertising spending in emerging markets like China, which has been exceptionally promising over the last years. Hershey has plenty of room for international expansion, and that brings some reminiscences to Coca-Cola back in 1988.

<img alt="" src="http://g.fool.com/editorial/images/20919/china_large.jpg" />

The company has enough brand power to translate raising commodity costs into higher prices for consumers, and management is dedicated to keeping costs at bay in order to sustain and increase profit margins. The firm plans to increase manufacturing efficiency and improve its cost structure over the next years. By 2014, Hershey expects these initiatives to generate an additional $60 million to $80 million in annual cost savings, on top of the $175 million-$185 million of savings generated from its global supply chain transformation.

Capital allocation efficiency, a variable which Buffett considers of utmost importance, is a big plus for Hershey; the company is well above its peers when it comes to return on invested capital.

<img alt="" src="http://g.fool.com/editorial/images/20919/roic_large.jpg" />

Hershey has an active stock buyback program and it has rewarded investors with growing dividends over the last years, another common trait with companies like Coca-Cola or Heinz. The firm has in fact increased quarterly dividends two times in 2012, first in February by a 10% to 0.38 and then again in August by another 10% bringing the quarterly payment to $0.42 per share.

<img alt="" src="http://g.fool.com/editorial/images/20919/div_large.jpg" />

Bottom Line

Buffett is in search of investment alternatives to deploy some of Berkshire´s growing cash balances. Considering that Hershey is a high quality company with strong competitive advantages in one of his favorite sectors, I would say The Oracle should consider taking a bite at this sweet opportunity.


Andres Cardenal owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway, Coca-Cola, and H.J. Heinz Company. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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