What will the second quarter bring us? Where will the big portfolio managers with huge amounts of money under management place their bets?
With growth slowing noticeably in this country as we finish Q1, I think they will be on the hunt for big, liquid growth stocks they can sink their teeth in. I think they will want to buy Heinz Kraft (KRFT), the new food company, and Actavis (ACT), the gigantic and fast-growing pharmaceutical rollup of existing older-line drug companies.
I know, these two stocks have already been shot out of a cannon. Kraft's been straight up since its merger announcement. Actavis has roared ever since it bought Forest Labs (FRX) and Allergan (AGN). Why do I think they can continue to run? It's the nature of the mechanics of the money management business; that's what's driving them up now and that's why I believe they will be rallying well into the second quarter.
You see, big portfolio managers are always on the hunt for stocks with clear growth paths that they can get in and out of with ease. They are going to redouble their efforts to find these kinds of stocks given the sluggish data we keep seeing.
Let's start with Actavis. Brent Saunders, the charismatic CEO, has created what he calls a leader in a new industry model, "growth pharma." This statement is extremely important because the landscape of big pharmaceuticals is riddled with slow-growth behemoths like Pfizer (PFE), Merck (MRK), Lilly (LLY), AstraZeneca (AZN) and Glaxo (GSK). One could argue that Bristol-Myers (BMY), Johnson & Johnson (JNJ) and AbbVie (ABBV) are faster-growing, but they all have their challenges, not the least of which is AbbVie's vast overpay for Pharmacyclics (PCYC) even as JNJ owns 50% of its most important drug.
Actavis, after the closing of its deal with Allergan, is much faster-growing than all of those companies, with competitive franchises in eye care, neurosciences, central nerve systems, aesthetics, dermatology, plastic surgery, women's health, gastroenterology and neurology. That's a real plethora of areas where the company has much better than average growth.
Allergan, in particular, gives Actavis an incredible product portfolio because the eye-care estimates do not consider the results we will see later in this year for the DARPin study for wet macular degeneration, which former Allergan CEO David Pyott often assured me could be bigger than Roche's Lucentis or Regeneron's (REGN) Eylea. Bold claims. Plus, Allergan's Botox, which Pyott described as a pipeline within a drug, could have many more applications given its impact on muscular use. Look for a blockbuster study for women's pelvic issues, a 40-million-person market, that could start as early as next year.
Put all that good news together and you could see why Saunders may not be off course with his $25-a-share aspirational goal for 2017, a roughly $10 increase from what he's predicting in 2015. No wonder stock investors snapped up a 13.25 million share secondary at $288 a few weeks ago, while bond investors salivated for the $21 billion in bonds including $3 billion in seven-year paper, $4 billion in 10-year, $2.5 billion in 20-year and $2.5 billion in 30-year bonds.
Starved high-yield buyers gobbled up these bonds, the second-largest fixed-income acquisition offerings after the Verizon (VZ) for Verizon Wireless deal, even as some of the paper was priced as high as 1.75 points over Treasuries. Talk about taking advantage of low rates. Plus, given the Dublin home of the tax-inverted Actavis, I fully expect we haven't seen the end of accretive deals as soon as the company starts paying down significant amounts of debt, which should begin as early as the second half of this year.
Actavis has so many irons in various fires and so many drugs up for approval in 2015 that there could be just an endless progression of positive news flow. Given these prospects, you can see that the $25 earnings per share potential seems reasonable. If you were to give it a 20 multiple because it would be the fastest-growing large pharmaceutical company, you can see how investors would be willing to pay $500 over time, and that will become evident with each earnings results going forward. Don't sniff; believe me, portfolio managers will buy this stock every time they get new money in over the transom.
But as hungry as the market has been for growth pharma, the demand for a consumer-product-goods growth stock has been even more overwhelming. So many companies in that group have barely any organic growth: Procter & Gamble (PG), Clorox (CLX), General Mills (GIS), Kellogg (K), Campbell (CPB) and the like.
That's why I wasn't the least bit surprised that big portfolio managers loved the Heinz for Kraft deal and have continued to walk the stock up ever since the announcement of the deal. Heinz, run by 3G and backed by Warren Buffett, has been able to grow the very tired ketchup-and-pickles company far beyond what that company had been able to do itself before the acquisition. 3G has tremendous smarts when it comes to emerging markets, venues where these brands truly resonate. At the same time, costs have come down. That's enabled somewhere north of $2 billion in additional earnings before income taxes, depreciation and amortization to be produced vs. an independent Heinz.
The domestic slow grower that is Kraft will soon become the fastest-growing overseas food company as it slides right into Heinz's distribution system. I think that's a given as Oscar Mayer, Jell-O, Velveeta and Kraft cheese and salad dressings, to name a few of some really little-growth old-line brands, would be clamored for when this North American spin-off is sent global by Heinz. People in those countries often aren't as attuned as we are to the desire for natural and organic, the antithesis of the Heinz-Kraft portfolio.
With that backing and with growth projections pretty much etched in stone, Heinz-Kraft is being regarded as a "can't miss" and that's why it's so wildly popular among portfolio managers. It could go to $100 without much of a brushback from eager institutions because there is a belief, not ridiculous, that Kraft was severely undermanaged and starved of worldwide growth opportunities because of its corporate structure post the split-off that gave the fastest-growing international brands to Mondelez (MDLZ).
As the stock journeys north, there are even more opportunities open to the combined entity. I have suggested that it would be a natural to buy WhiteWave (WWAV) when the heavy tax burden of an acquisition goes away in May. An acquisition of Hain Celestial (HAIN) would also make sense. But Warren Buffett, in an answer to my question about how Kraft is filled with pantry goods that are processed and unnatural, simply said they were great brands for 30 years and they will be great brands in the future. The problem with that logic is the same thing could have been said about Coca-Cola (KO), and there is no doubt the growth in that once totally hypercharged company left the building years ago. The endless cash flow, however, from a company that sells sugar water is undeniable. It's also not 3G's style to pay up for already well-run brands like WhiteWave and Hain.
There's another candidate for acquisition out there and that's Mondelez itself, the other part of old Kraft, the international snack growth vehicle that could be put back together with a company it should have never separated from. Why not? The new entity would be faster-growing and much better run.
One other thought: Heinz Kraft might be able to buy the private Mars company, which has a close association with Buffett back from when he loaned Mars money to buy Wrigley in 2008. That was a fabulous transaction for all involved and if Mars, with elder heirs, wants to sell, then this new vehicle would be the obvious choice. Either way, there are so many abilities for this deal to turn out positive that the endless buying makes sense to me, especially when you throw in the $16 special dividend. No one will ever be hurt buying this company.
Actavis and Heinz-Kraft, two situations that fill the needs of portfolio managers everywhere. They can go higher without much effort and I think, judging by the plaudits they have garnered, they probably will continue to soar as portfolio manager fan favorites going into a quarter widely perceived of being starved of growth, something that both have in spades.
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