Kraft to Pay Special Dividend Following Heinz Merger

US company Kraft Foods, who bought out British confectioners Cadbury in 2010, is to merge with beans-manufacturer Heinz in a deal backed in part by Warren Buffett

Erin Lash, CFA 25 March, 2015 | 4:45PM
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Morningstar equity analysts are considering the fair value estimate for narrow-moat Kraft Foods (KRFT), and are likely to take up our valuation by more than 10%, as we digest the details of the company's plans to merge with privately held Heinz. Kraft shareholders are poised to receive a $16.50 per share special dividend, as well as own 49% of the combined firm, with the transaction set to close in the second half of 2015.

Kraft-Heinz would become the third-largest food and beverage firm in North America

We estimate the newly created entity will possess an enterprise value of around $70 billion, as compared with Kraft's $46 billion enterprise value prior to the transaction being inked, and an equity valuation of around $50 billion-$55 billion after accounting for debt and the special dividend.

Our initial take is that the deal stands to enhance Kraft's narrow economic moat, which is derived from the firm's solid brand intangible asset and economies of scale on its home turf. As a combined firm, Kraft-Heinz would leapfrog Coca-Cola (KO) to become the third-largest food and beverage firm in North America behind PepsiCo (PEP) and Nestle (NESN), boasting more than $22 billion in sales in 2014, and $29 billion on a consolidated global basis.

From our vantage point, its brand strength would be sound, with eight brands generating more than $1 billion in annual sales and another five garnering $500 million-$1 billion in sales each year. Management further anticipates beefing up the efficiency of its business, similar to the success Heinz has realized--its EBITDA margins soared to 26% in fiscal 2014 from 18% pre-deal in mid-2013. It plans to do this by cutting $1.5 billion in costs from its operations, representing 10% of Kraft's annual cost of goods sold and operating expenses.

We also surmise revenue synergies are attainable, as Kraft, the bulk of whose sales come from the United States and Canada, can now sell its fare across Heinz's vast global distribution platform, which derives 60% of sales outside North America, including 25% in emerging and developing markets.

From a portfolio management perspective, we also believe a fair amount of brand pruning could be in the cards, similar to the actions private equity company 3G has taken since owning Heinz, such as shedding Shanghai Long Fong Foods in China and the U.S. foodservice dessert business in 2013.

For one, we've thought for some time that Jell-O, which continues to falter despite multiple stabs at putting it on more stable ground, could be axed in favour of allocating more capital to faster-growing categories such as organics, or even pursuing a tie-up outside the United States, and believe this could occur in a more rapid fashion under its new ownership.

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About Author

Erin Lash, CFA  Erin Lash, CFA, is a senior stock analyst with Morningstar.

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