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The Stocks Of Warren Buffett - Kraft

January 02, 2011 | About:
Josh Zachariah

Josh Zachariah

36 followers
One of the more disappointing stocks Buffett picked in recent years was his Kraft investment. In 2006 he acquired several billion in shares of Kraft at a price above $30. It remains around that price, though it is paying a fairly high dividend above 3.5%. Early in 2010 when the company was in the process of acquiring Cadbury he was quoted as saying it is still undervalued, but not nearly as much prior to the acquisition as he believed they overpaid for Cadbury.

The Cadbury deal has so far turned out to be less of the boost than was expected. Earnings growth related to the chocolate business turned out to be less than the Kraft’s overall earnings growth. Kraft was also forced to issue its own shares to finance the transaction at a share price which both Buffett and the board of Kraft believed to be undervalued.

As mentioned earlier, Buffett noted the stock was still undervalued. By a price to earnings measure, it did not seem incredibly cheap. However, the price to book looks much cheaper, especially in relation to its competitors. The below chart shows the price to book of Kraft and its competitors. KFT = Kraft, HSY = Hershey, CAG = Conagra Foods, K = Kellogg. Generally companies with strong brands tend to sell at a marked premium to book value. Conagra is not nearly endowed with the quality brands that Kraft holds, yet its premium to book value is nearly 25% greater than Kraft’s. Conagra also trades at a price to earnings of 14.34 to Kraft’s 12.16.

Explore moreKFT)/Data/Key_Metrics?ref=chart">KFT Data atWikinvest


Buffett describes book value in his 1983 shareholder letter as the accumulation of contributed capital and retained earnings in the company. He uses the book value measure in valuing Berkshire Hathaway because it is a conservative proxy for valuation rather than the more subjective intrinsic valuation of the firm. He contrasts the two; "book value tells you what has been put in; intrinsic business value estimates what can be taken out." What can be taken out is necessarily the dividends that result from the future free cash flows. For a complex firm like Berkshire Hathaway, calculating future free cash flows is no easy task.

The growth in Kraft's book value has been benign at best, growing at slightly over 2% per annum for the past 9 years as the graph below shows. Earnings per share growth and thus the retained earnings that get plowed back into the firm has also been low at around 4% per annum for the past 9 years. Management does project a much higher growth rate. Conagra, Kellogg and other of Kraft's competitors have logged a higher growth rate in book value which would justify a steeper price/book. If Kraft can notch up a higher growth in earnings, it would certainly give a boost to book value and would warrant the firm to trade at a higher price/book.



A separate analysis of Kraft's expected earnings can be found here on Motley Fool.

Disclosure: Holding shares in Kraft

Josh Zachariah

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.3/5 (11 votes)

Comments

Berkshire411
Berkshire411 - 3 years ago


Why bash Warren? When did Berkshire unload their Kraft shares? He has said it was a very dymb deal by Kraft, selling something for 9x earnings to purchase something at 16x earnings. The article is useless without facts, why not bash him for saying Freddie Mac was a good buy at one point and not point out that he sold it years ago?

Scott
extramiler
Extramiler - 3 years ago
I don't understand why Warren likes (or liked) KFT so much. It has low margins, low ROE, cash flow is not great. Some great high margin brands mixed with low margin commodity businesses. I'm not questioning WEB; I am questioning myself: what is it that attracted him to this stock?
Gangstarr
Gangstarr - 3 years ago


Go look in your pantry or refrigerator. Look again in ten years. Notice anything? Even if you buy discount brands from Walmart, he owns a piece of that too!

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