Besides Kellogg, What Other Food Companies Could Be Buffett’s Next Target?

There have been rumors swirling that Kellogg (K 1.05%) is a potential acquisition target for Warren Buffett and his holding company Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) .

Buffett looks for companies with strong returns on equity and capital, abundant cash flows, low debt, and well-known brands that own a piece of the consumer's mind. He also likes to pay a fair price for those criteria. Kellogg certainly has sold returns on equity and capital, strong cash flows, and recognized brands, but is its current price in line with paying for those desired qualities?

Maybe some of Kellogg's competitors in the food sector such as Kraft Foods Group (KRFT.DL), ConAgra Foods (CAG 0.96%), or General Mills (GIS 1.12%) would make better investment sense for Buffett. Kellogg's peers in the food industry also have good returns on equity and capital, strong cash flows, and acclaimed brands. In this article, I will evaluate these companies against Kellogg to discern which company best fits the investment strategy of Buffett and Berkshire Hathaway.

Data Source: MSN Money & Morningstar (ROE & ROC in %)

*Kraft separated into Kraft Foods Group & Mondelez, so only three fiscal years are available for Kraft as a separate company.

All four companies have good returns on equity over the last five years. ConAgra has the lowest ROE on average over the last five years at 15.5%, but that average is nothing to snark at and most companies would love to have such an average over the last five years. Still, Kellogg's ROE over the last five years is truly startling at 58.2%. Considering this, it is easy to see why Buffett would be interested in acquiring Kellogg and adding this rate of return to Berkshire's portfolio.

All four food producers have more debt on their balance sheets than equity as displayed in their debt/equity ratios, but all of them also generate substantial returns on capital to cover their interest costs. ConAgra has the lowest average ROC over the last five years at 9.6%, but that average is still decent and does not put the company into any immediate trouble. Nonetheless, like ROE, Kellogg comes out on top with an average ROC of 17.6% over the last five years. This is a great ROC and shows Kellogg's ability to generate strong earnings to cover its capital costs.

Buffett is looking for companies with strong cash flow, not just strong earnings. All of the companies fit that bill except for ConAgra. ConAgra was free cash flow negative in 2008 and 2009, but has recovered and has generated positive free cash flow in every fiscal year since 2010. Therefore, ConAgra could still be a potential target for acquisition, but less so than Kellogg, Kraft, or General Mills as those three companies have not had any hiccups in their ability to generate free cash flow over the last five years.

Buffett wants to pay a fair price

Data Source: Yahoo Finance & Morningstar

All of the companies trade at discounts to the S&P 500 on a trailing earnings basis, save General Mills. The S&P 500 trades at a current P/E of 18 and Kellogg and Kraft have P/E values at or a little above 13, while ConAgra has a P/E of about 17. On a forward earnings basis, ConAgra looks the most attractive with a forward P/E of 13.6 and a five-year PEG of 2.23 – both the lowest among the four companies. Kellogg, surprisingly, has the highest PEG out of the four companies. Still, the forward P/E and PEG consider analyst estimates, and Buffett is more interested in past ability to generate earnings and cash flow and an ability to sustain that in the future.

Interestingly, ConAgra looks the cheapest considering its ability to generate cash flow from its operations with a P/CF of 8.8. The S&P 500 has a current P/CF of 11, so ConAgra trades at a discount and the other three companies trade at premiums to the market on this basis. However, ConAgra is more expensive than Kellogg or Kraft considering their enterprise values. ConAgra's EV/EBITDA ratio of 9.9 is ahead of Kellogg's and Kraft's equal ratio of 8.4. General Mills' EV/EBITDA is the most expensive out of the four companies at 12.

Which company should Buffett buy?
Kellogg is definitely impressive in its ability to generate returns on equity and capital. Moreover, Kellogg perennially generates positive free cash flow and generates its returns even with a substantial amount of debt. The other companies are also impressive but less so than Kellogg with respect to ROE and ROC. Furthermore, only ConAgra has failed to generate positive free cash flow in every year over the past five years.

On a valuation basis, a consensus company for Buffett to buy is not reached through evaluating the metrics here. ConAgra actually looks attractive on some valuation multiples, but is less attractive than the other companies in its ability to generate investment returns and cash flow. Kellogg's current P/E is low compared to the S&P 500's, but its current P/CF is a little pricey compared to the S&P 500's.

Although Kellogg is not a screaming buy with the valuations considered here, its ROE, ROC, and cash flow generation all meet Buffett's and Berkshire Hathaway's investment rubric.