Mergers of Food Companies Can Be Hard to Digest

 | Mar 01, 2017 | 9:00 AM EST
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When it comes to food company deals, it's hard to find the right recipe.

Kraft Heinz (KHC) recently walked away from a contemplated $143 billion combination with Unilever (UN) , a merger that could have created one of the world's largest producers of packaged foods, from lunch meats, Jell-O and ketchup to tea and mayonnaise. Just six months earlier, Mondelez (MDLZ) , the maker of Cadbury chocolate and Ritz crackers, abandoned its attempt to buy confectioner giant Hershey (HSY) . (Kraft Heinz is part of TheStreet's Action Alerts PLUS portfolio.) 

Many believe Kraft could go on the hunt again, with Mondelez being a possible target, but Warren Buffett, who partly backed the Kraft Heinz deal a few years ago, said on CNBC the Unilever deal was the only deal he would consider. "There isn't any backup deal. That was the only one that certainly I seriously thought about that made sense," said Buffett.

Merging is one way for companies to slash costs and reach new markets, something Unilever, Coca-Cola (KO) and General Mills (GIS) are under pressure to achieve. The same is true for restaurant groups. The parent of Burger King and Tim Horton's, which is owned by the same private-equity firm that has reshaped Kraft Heinz, announced a tie-up with Popeyes Louisiana Kitchen (PLKI) just days after Kraft's plans for Unilever leaked out.

Lofty plans haven't always delivered. Campbell Soup (CPB) , trying to extend its reach beyond canned soup, spaghetti sauce and Goldfish crackers, made a push into fresh foods with two acquisitions in the last five years but has struggled with declining sales in that division.

Kraft Heinz is itself the product of a 2015 merger orchestrated by 3G, a partnership of Brazilian billionaire bankers who have developed a reputation for taking over companies, replacing management and relentlessly cutting costs. They are the same team behind the creation of brewing giant Anheuser Busch InBev (BUD) through multiple acquisitions, and they have a proclivity for making unsolicited offers, having made several unwanted offers for SABMiller in 2015 before finally arriving at a deal.

With food companies in the headlines and deal news swirling around, there might be some overlooked opportunities that present investors with reasonable entry points and decent valuations.

Fresh Del Monte Produce (FDP) , the producer of canned fruits and vegetables and prepared foods, reported a fourth-quarter profit after a loss the prior year. It currently scores high in the model that tracks the investment philosophy of Peter Lynch, who made his name in the 1980s running Fidelity's Magellan fund. It is a large company that still offers long-term potential, with earnings growth of 18.9% per year based on the average of the four- and five- year historical EPS growth rates, and annual sales of $4 billion. The stock has a P/E of 13.3, making the PE/G ratio, a Lynch favorite, an attractive 0.68.

Tyson Foods (TSN) , the chicken and meat producer, has been dealing with lawsuits and a federal investigation into whether companies are manipulating chicken prices, which has contributed to a recent decline in its shares. But the company also scores highly according to multiple models I run. The Lynch model likes the valuation and growth rate, while the Growth model I run based on the Martin Zweig investment methodology likes the recent earnings growth and persistence.

Avocado producer Calavo Growers (CVGW) is also a "fast grower" under Lynch's standards, with a price-to-earnings of 26.3 and a growth rate of 21.9%, based on the average of the four- and five-year historical EPS growth rates. The value-oriented model I run based on Ken Fisher's Super Stocks method also rates the stock highly, largely a result of its P/S ratio of 1.1 and long-term EPS growth rate.

Church & Dwight (CHD) , while not a food concern, is a non-cyclical name that looks to have some attractive investment characteristics. The company makes household and personal-care products under brands such as Arm & Hammer, Oxiclean and VitaFusion. The model I run that tracks investment guru Warren Buffett, who likes stocks of companies with strong brands and superior competitive positioning, gives the stock a score of 79% (out of 100%). My Buffett model is a very stringent approach, looking at 10 years' worth of earnings and other quality factors. In my entire universe of 6,000-plus stocks I analyze, only 50 other names score higher than Church & Dwight through the lens of the Buffett method. Shares have run up this year and the company said it would raise its dividend by 7% starting in March.

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