There have been repeated rumors in recent months that Campbell Soup (CPB) may be acquired by Kraft Heinz (KHC). The former is in the process of pursuing a sale of the company while Kraft Heinz is well-known for pursuing acquisitions in the food sector. Therefore, the big question is whether this merger will eventually materialize.
While Campbell Soup has a 149-year history, it has been facing unfavorable secular trends in recent years. Consumers are becoming increasingly health-conscious and thus the popularity of the flagship products of the company has fallen. Campbell Soup has turned its focus on some brands that appeal to health-conscious consumers, but these brands have proven insufficient to outweigh the secular decline of the other brands so far. Consequently, Campbell Soup has failed to meaningfully grow its organic sales in the last five years and has dramatically underperformed S&P during this period, as it has lost 1% whereas S&P has rallied 70%.
Management has not succeeded in addressing the challenges facing the company and seems to have accepted the fact that a turnaround is unlikely. It is thus in the process of finding a strategic buyer for the company. Last month management announced the sale of the international unit and refrigerated-foods unit. These two units generate about 25% of the total sales of the company. However, Third Point hedge fund, a major shareholder, is not satisfied with this move and will continue to exert pressure for a sale of the whole company.
Kraft Heinz is well-known for its strategy to grow via acquisitions. After its takeovers, the company implements drastic cost-cutting measures and thus achieves impressive synergies, which render the acquisitions highly profitable. The CEO of the company has repeatedly stated that he is on the hunt for the next major takeover in the food & beverage sector. He also recently stated that the valuations in the sector are much more attractive now than they were a year ago.
A research analyst at Euromonitor recently claimed that Kraft Heinz could acquire Campbell Soup for its snack portfolio rather than its canned soup business. Thanks to its recent acquisition of Snyder’s Lance, Campbell Soup has seen its portfolio of snacks and biscuits grow 50%. As a result, these products now generate approximately 45% of its total sales.
However, Campbell Soup still has a long way to assimilate its acquisition of Snyder’s Lance for $6.1 B. As its total market cap currently stands at $12.4 B, it is evident that the acquisition was a transformational one. This means that it will probably take years for Campbell Soup to absorb the takeover and achieve the synergies that are required to render the merger profitable. It is really unlikely that Kraft Heinz will attempt to acquire Campbell Soup, as the transformation of the resulting entity will be markedly complicating, given that the takeover target is already going through a major transition.
Moreover, Kraft Heinz is currently facing the same negative secular trend that Campbell Soup is facing, namely the increasing preference of consumers towards healthier products. This is evident in the performance of Kraft Heinz, which has failed to grow its organic sales in recent years. To cut a long story short, it does not make sense for Kraft Heinz to pursue a complicated acquisition of a takeover target, which has failed to address the same challenges that are facing Kraft Heinz.
It is also worth noting that Campbell Soup has a much lower operating margin that Kraft Heinz. The former currently has an operating margin of 17.2% while the latter has a margin of 24.8%. In addition, Campbell Soup has a markedly leveraged balance sheet. More precisely, its net debt (as per Buffett, net debt = total liabilities – cash – receivables) stands at $12.1 B. As this amount is 25 times the annual earnings of the company, it is certainly excessive. The inferior operating margin of Campbell Soup and its huge debt load render the company less attractive as a takeover target.
It is also important to note that Campbell Soup is currently trading at a forward P/E ratio of 16.4. While this valuation may not seem extreme on the surface, it is certainly rich, particularly given the leverage of the company and the absence of earnings growth. Even worse, if Campbell Soup is acquired, it will demand a significant premium on top of its current valuation. It is very unlikely that Warren Buffett, who is a major shareholder in Kraft Heinz, will ignore the excessive valuation of his takeover target and approve of such an acquisition.
To conclude, Campbell Soup is trying to sell itself, but it is unlikely to be acquired by Kraft Heinz under the prevailing market conditions. The two companies are facing similar secular challenges while Campbell Soup has a huge debt pile, rich valuation and is trying to assimilate its recent transformational acquisition of Snyder’s Lance. The only circumstance in which Kraft Heinz may become interested in such a merger is the event of a major bear market, which will render the valuation of Campbell Soup more attractive. However, in such a case, the shareholders of Campbell Soup are not likely to earn a meaningful premium on top of the current valuation of the stock.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Be the first to comment