What does Buffett see in Heinz (HNZ)?

H. J. Heinz Company (HNZ), together with its subsidiaries, manufactures and markets food products for consumers, and foodservice and institutional customers in North America, Europe, the Asia Pacific, and internationally. The company had consistently boosted dividends since 2003. Over the past week, Heinz agreed to be acquired by Berkshire Hathaway and a private equity firm 3G Capital for $72.50/share. The size of this acquisition fits the elephant category that Buffett often describes in his annual letters to shareholders. In a previous article, I discussed why Buffett likes dividend stocks. This is another dividend growth stock, that attracted Buffett's attention. So what makes this company an interesting bet?

Warren Buffett, Chairman and CEO of Berkshire Hathaway said, “Heinz has strong, sustainable growth potential based on high quality standards, continuous innovation, excellent management and great tasting products. Their global success is a testament to the power of investing behind strong brand equities and the strength of their management team and processes. We are very pleased to be a part of this partnership.”

First of all, the company carries a strong brand name. Everywhere you go out to eat in North America, you can find Heinz ketchup. Consumers are aware of the brand, and are trained from very young age into being repeat customers, without even realizing it. As a result, the company has pricing power to pass on cost increases to customers.

Second, the company is being purchased at a decent valuation. Based on the expected EPS for 2013 of $3.54/share, the acquisition price is equal to 20.50 times earnings. Analysts are forecasting $3.79/share in 2014 earnings and a 6.60% annual growth over the next five years. The company is also paying $2.06/share in annual dividends, which would have likely increased, had it stayed public . Berkshire is expected to finance the deal with $12.12 billion, with $8 billion being in preferred stock yielding 9%, while the remainder will provide them with equity exposure in Heinz. They will split it with 3G Capital Partners.

Third, the business has room to grow internationally. Heinz has a 59% market share in the US ketchup market, while only a 26% internationally. With the “westernization” of emerging markets, and the rise in the middle class, Heinz will probably gain more prominence, which would result in higher sales and profits. Furthermore, the company also owns other strong brands such as Weight Watchers, Smart Ones and Ore-Ida.

Dividend stocks make great acquisitions. These slow and steady businesses with dependable growing cashflows are perfect for investors that own 1 share to 100% of the shares. In the case of Heinz, the company is trading at 20 times earnings today. However, it will likely grow at a steady rate, and deliver great dividends to owners for decades to come, as it has for decades before. The firm has paid dividends since 1911, and has raised them since 2003. Before that, it had raised dividends for almost 39 years in a row, but cut them at the end of 2002. Given the strong momentum in earnings, investors would have enjoyed much better long-term returns going forward. I have no doubt in my mind that Heinz would have managed to become a dividend achiever at the end of this year.

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