Warren Buffett, Chairman and CEO of Berkshire Hathaway (BRK.B), is arguably the greatest investor of our time. Through Berkshire Hathaway, Buffett owns several privately-held subsidiaries such as GEICO and Fruit of the Loom. Berkshire also owns large investment stakes in a number of publicly-traded companies. Of the many Berkshire Hathaway stock holdings, income investors should take a closer look at food and beverage giant Kraft-Heinz (KHC), because of its high dividend yield of 4.3%.

Kraft-Heinz has had a difficult year. Consumer tastes are shifting rapidly in the U.S., away from packaged foods. Instead, consumers are demanding healthier and fresher alternatives, such as organics. Kraft-Heinz has been caught off-guard by this. But it is investing in new products, and still has growth potential, particularly in the emerging markets. While investors wait for the turnaround, shareholders are paid well to wait with Kraft-Heinz’s high dividend yield of 4.3%.

This makes Kraft-Heinz a potential buy for value and income investors.

Business Overview & Current Events

Berkshire Hathaway is Kraft-Heinz’s largest shareholder, with over 325 million shares. Berkshire Hathaway owns approximately 27% of the company. Kraft-Heinz was created in 2015 in a merger between Kraft Food Group and H. J. Heinz Company. Today, it is a processed food and beverages giant whose product portfolio includes condiments, sauces, cheese & dairy, frozen & chilled meals, infant diet, and nutrition. A sample of its core brands includes Kraft, Heinz, Oscar Mayer, Velveeta, Maxwell House, Philadelphia, Ore-Ida, Planters, and Kool-Aid.

In all, Kraft-Heinz has 8 brands that each collect $1 billion or more in annual sales. It has another five brands that generate $500 million to $1 billion in sales, and several more that each bring in $100 million or more in sales.

Source: Integration Presentation, page 4

Over the past several years, these brands have become household names for millions of consumers. It is possible that virtually every household in America currently has one or more of these products in their homes right now. At the same time, growth of these legacy brands has stalled.

Kraft-Heinz reported its second-quarter earnings results on August 3^rd. The company reported earnings per share of $1.00, an increase of 2% year over year. Revenues rose by 1%, hitting $6.7 billion during the second quarter. Kraft-Heinz beat analyst expectations for both revenue and earnings-per-share last quarter. Sales growth last quarter included a favorable 0.3% impact from currency and a 0.8% boost from acquisitions. Organic sales declined by 0.4% for the quarter 0.4 percent versus the year-ago period. Pricing increased 1.3%, while volume and product mix had a negative impact of 1.7% last quarter.

Growth Prospects

Kraft-Heinz’s growth has slowed over the past year, but the company is still reporting positive growth. It also expects growth to accelerate heading into 2019. New products are being developed to better align with changing consumer tastes in the U.S., and the emerging markets continue to be a major growth catalyst moving forward. For example, last quarter, Kraft-Heinz generated 4.0% organic sales growth in its Europe, Middle East & Africa (EMEA) region. Growth was due primarily to 5% volume growth, which indicates strong product demand in these regions. EMEA segment adjusted EBITDA increased 2.9% on an organic basis last quarter.

Another growth region is Kraft-Heinz’s “Rest of World” geographic segment, which includes Asia-Pacific and Latin America. This segment performed even better than EMEA. Rest of World organic sales increased 10.8% last quarter, due to 9.2% pricing increases and 1.6% volume growth. Kraft-Heinz enjoyed especially strong results from condiments and sauces across these regions. Rest of World segment adjusted EBITDA increased 32% last quarter.

In addition to sales growth through higher volumes and pricing increases, Kraft-Heinz’s earnings growth will receive a boost from innovation, and tax reform. In product innovation, Kraft-Heinz is investing aggressively in new channels, particularly e-commerce. This is a highly attractive channel for strong consumer brands, as it provides the opportunity to sell more of their products to customers much faster than before. Kraft-Heinz exceeded 75% e-commerce growth in the U.S. last quarter and over the first half of 2018. And, the company expects an effective tax rate of 21% for 2018, which will be a tailwind for earnings growth.

If Kraft-Heinz can continue to grow earnings, even at a modest rate, shareholders are likely to generate high returns over the next several years.

Dividends & Expected Returns

One of the most attractive aspects of Kraft-Heinz stock is its hefty dividend. The company currently pays an annualized dividend of $2.50 per share. Based on its recent share price, Kraft-Heinz has a dividend yield of 4.3%. This is more than double the average dividend yield of the S&P 500 Index. The dividend payout appears to be secure, as Kraft-Heinz is expected to generate earnings-per-share of $3.72 for 2018 according to consensus analyst estimates. This results in an expected dividend payout ratio of 67%, meaning Kraft-Heinz is likely to distribute roughly two-thirds of its earnings-per-share. This is a manageable payout ratio, which even provides room for modest dividend increases moving forward.

The dividend plays an important role in Kraft-Heinz’s overall expected returns. Valuation changes and earnings growth will also contribute to shareholder returns. Even if Kraft-Heinz grows earnings at a modest rate—around 5% per year—the stock will still provide satisfactory returns. Expansion of the price-to-earnings ratio could also fuel annual returns of 2%. Kraft-Heinz stock currently trades for a price-to-earnings of 15.4, compared with a fair value estimate of 17.0, which indicates the stock is undervalued.

The combination of valuation changes, earnings growth, and dividends, could result in total expected returns of more than 11% per year over the next five years. This is a highly attractive rate of return for a relatively low-risk dividend stock.

Final Thoughts

Kraft-Heinz, like many other large packaged food companies, was caught flat-footed by the rapid changes in consumer preferences. And, the consumer goods industry is also grappling with raw materials inflation, which threatens to compress margins. This explains why Kraft-Heinz stock has dropped 25% since the beginning of 2018.

However, Kraft-Heinz retains a large portfolio of industry-leading brands. It is bringing new products to market in new channels, and is expanding rapidly in the emerging markets. These catalysts should allow for continued growth over the next several years. In the meantime, investors receive a hefty 4.3% dividend yield, which pays shareholders well to wait.

The post Kraft-Heinz: A Warren Buffet With A Secure 4.3% Dividend Yield appeared first on Modest Money.