Can These Consumer Goods Stocks Fatten Your Portfolio?

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

Consumer goods companies are key in any of my portfolios. They are highly prone to M&A given their high cash flow generation capabilities, the demand for their products almost always probes to be inelastic and they have huge room to grow in emerging markets (EM) from Asia to Latin America. All these positives come with one negative truth: CGCs are almost always expensive. That said, its important to keep an eye on them and buy when they seem fairly priced. Every now and then, opportunities appear. Let's take a look at my favorite 'food' company portfolio right now (given current market prices).

The Hershey Company (NYSE: HSY) is, as you may know, a chocolate and candy producer. Not only are its products highly inelastic in the US, but also the company is growing fast in EM, above all in China. Operations are doing great: new products like Minis, recently acquired Brookside, and Simple Pleasures are helping the company produce over $750 million in cash flow every year. Growing at a 20% rate in EM and growing its dividend by more than 10% Year over Year (YoY) - the 2013 dividend yield stands at 2.3% - I think Hershey can perfectly justify its 2013 20x P/E and 11x EV/EBITDA. With a market capitalization of $16.4 billion it's a compelling M&A candidate for giants such as Mondelez International (NASDAQ: MDLZ) or Buffett's Berkshire Hathaway.

Specaking of Mondelez International is the world's largest chocolate, biscuit baker and candy maker, and the second largest maker of gum. The company may sound new to you but it is not. MDLZ is what was left from the Kraft business following the spin off of Kraft Foods Group out of the parent company. MDLZ has a beautiful and resilient growing business in Western Europe and a strong profitable business in developing countries (45% of sales with double digit margins). That said, the company didn't have a great Q3 and this has weighted on the stock's price. Even if EPS came in line with expectations, organic sales grew only 1.5% with developing markets not delivering the growth rates that were expected thanks to some executional problems in Brazil and Russia. The current valuation doesn't reflect the strong business motto around Mondelez. Its distribution network is impossible to replicate and its brands carry an enormous amount of goodwill. Valuation stands at 2013 16.5x P/E and 11x EV/EBITDA. Even if the 2% annual dividend yield seems low its poised to grow over time.

Kraft Foods (NASDAQ: KRFT) is my dividend pick in this CGC portfolio. It pays a healthy 4.2% yield with a payout ratio at 77% (which is sustainable for Kraft). Besides, management plans to grow dividends by 8% every year. Kraft, operating with a growing 34.8% gross margin and growing sales at a 3% YoY rate, trades at fair (not cheap) multiples: 2013 17x P/E and 12x EV/EBITDA. Its market strength and high dividend makes KFRT a strong candidate for any portfolio.

Additionally, these companies offer fair dividend yields. After all CGCs are cash cows growing sales and in the process of ameliorating margins. In the specific case of KRFT, management is aiming to achieve a 37% gross margin (from the current 34.8%) which is the standard for this industry. In the case of Mondelez, sales growth is going to come back soon while Hershey is just doing great and I expect most of the long term upside to come from this company. Remember, CGCs rarely seem cheap, but still they almost always show to outperform the market in the long term. Buffett and his performance are a good proof of that.

Fool blogger Federico Zaldua does not own shares in any of the companies mentioned in this entry. The Motley Fool has no positions in the stocks mentioned above. 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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