With markets having a robust start to the year, one of Buffett’s most significant holdings has dawdled. Kraft Heinz (KHC, Financial), his second-largest position, was the only one in his portfolio to trade near its lowest price in a year this week.
Buffett obtained the position when he helped orchestrate the merger between Kraft and Heinz that created the company. Buffett and his partner 3G Capital put up $10 billion in cash as part of the deal to pay shareholders a $16.50 dividend. Afterward, Buffett owned 325,634,818 shares, or 27% of the company and 50.6% together with partner 3G Capital. At year-end 2017, the stake was valued at $25.25 billion, down from $28.4 billion at the end of 2016.
Prior to uniting the companies, Buffett owned roughly 53% of Heinz, having paid $12.12 billion, which consisted of $4.12 billion in common stock and $8 billion in preferred stock with warrants. The preferred stock paid Berkshire roughly $720 million a year in dividends.
The combined Kraft Heinz became the fifth-largest food and beverage company in the world, with eight $1 billion brands.
3G has been known to make big cuts at companies it has bought out in the past, such as H.J. Heinz, where it worked with Berkshire to reduce its total debt to EBITDA to 6.2x in 2014 from 8.9x in 2013, according to Fitch Ratings. They achieved this by increasing EBITDA by 35% on lower overhead and manufacturing costs with more than $1 billion in debt repayment.
Kraft Heinz’s merger also resulted in high leverage, reaching debt to EBITDA of 4.8x, Moody’s reported in 2015. Since taking over at the company, 3G and Berkshire have saved money through means such as reducing fixed costs and overhead. The changes, including $2 billion in debt repayment, will lead to EBITDA dropping to the mid-3x range by 2019, Fitch calculated.
“[3G’s] method, at which they have been extraordinarily successful, is to buy companies that offer an opportunity for eliminating many unnecessary costs and then – very promptly – to make the moves that will get the job done,” Buffett said in a 2015 annual letter.
A tough retail environment has put the pinch on growth, however. Kraft Heinz eked out a 0.7% increase in net sales in the third quarter, which included a 0.4% benefit from currency. Driving the increase was higher pricing, which beat out a rise in input costs around the world and increased promotions in the U.S.
Kraft has been applauded for its wide margins, where 3G’s aggressive measures and the redemption of Buffett’s preferred shares have driven visible improvements. For the third quarter, the company reported 26.3% operating margins, up from 22.55% a year prior. Competitor General Mills (GIS, Financial), by contrast, has an operating margin of 17.38%, down from 18.7%, and Kellogg (K, Financial) reported 14.18% versus 12.6%
Net income rose to 12.1% to $944 million for the third quarter as expenses for its integration program and restructuring declined. Cost savings also began to grow, with lower overhead costs and higher prices contributing. A higher tax rate of 30.6% versus 23.7% offset some of the gains.
Kraft had set several goals for the merger by full-year 2017: to achieve $1.5 billion in annual cost savings and to be earnings per share accretive, which will provide a further indicator of how it is progressing on its initiatives.
The price of Kraft Heinz shares rose 2% year to date to $78.70 per share, which is 4.6% above their 52-week low.
