Hey Mr. Buffett, These Companies Are Just Like H.J. Heinz Company (HNZ)!

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LONDON — What’s so special about H.J. Heinz Company (NYSE:HNZ), that Warren Buffett — together with private equity group 3G — will shell out $28bn to buy it?

The price is certainly no steal, valuing the company at 21 times forward earnings. That’s a 20% premium to its all-time high share price, providing an unexpected bonus for investors who were shrewd enough to spot Heinz’s value.

I think there are at least two companies on the LSE with similar characteristics: Unilever plc (ADR) (NYSE:UL) and Reckitt Benckiser. But let’s first take a quick look at Heinz itself.

H.J. Heinz Company (NYSE:HNZ)The power of brands
The company is synonymous with the brand name that adorns its tomato ketchup, baked beans, and baby food. In fact, about 40% of turnover comes from products bearing the Heinz brand.

The power of strong consumer brands is double-barrelled: they provide safe and reliable cash flow in established markets, and they form a bridgehead to enter new markets. In “Buffettology,” brands create an economic moat that protects a company’s earnings.

Though originally a dyed-in-the-wool U.S. family firm, founded in 1869, international expansion has taken Heinz’s non-U.S. sales up to 60% of its global revenues. More recently, growth has come from emerging markets. They now account for a quarter of sales, up from 5% a decade ago.

Distinguishing features
Buffett has often favored easy-to-understand companies with strong track records and solid financials. Overall, the factors that I think make Heinz worth 20% more to Warren Buffett than the market was valuing it at are:

1). Internationally recognized consumer brands

2). Growth in emerging markets

3). Solid earnings record

4). Good cash flow

5). Sound balance sheet

Unilever and Reckitt Benckiser share these characteristics.

Both claim sales in over 180 countries. Unilever’s food, beverage, health and home businesses comprise brands such as WallsBen and Jerry’sDove and Lux.

RB is focusing on health and hygiene as well as its home products and has a non-strategic but financially important pharmaceuticals division. Its brands include names such as DettolFinishDurex, and Gaviscon.

Growth and safety
Unilever has the march on both Heinz and RB in its penetration of emerging markets, which generate 55% of its sales. RB is catching up with 44%, aiming to bump that up to 50% by 2015. The rise of a middle class with discretionary spending power makes for much better growth prospects in emerging markets.

RB wins on earnings record, with turnover and earnings per share rising consistently for at least the last decade. While Unilever’s track record is patchier, few would doubt the solidity of its earnings power.

Both companies generate prodigious cash flow. Last year Unilever delivered 4.3 billion euros of free cash flow from a 7 billion-euro operating profit, while RB’s 2.4 billion-pound operating profit generated 1.7 billion-pound free cash flow. Net gearing at the two firms is 47% and 41% respectively, with lashings of interest cover.

Not cheap, but cheaper
Unless you’re Warren Buffett, you’re not going to buy the whole company. The flip side is that you don’t have to pay a 20% premium to get hold of the stock.

Trading on forward earnings multiples of 18 and 17 respectively, Unilever and RB are cheaper than Buffett’s purchase price for Heinz. They are more expensive than the average FTSE company, but there’s no doubt that, in buying Heinz, Buffett was following his own maxim that it’s better to buy a wonderful company at a fair price, than a fair company at a wonderful price.

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