Why Warren Buffett Might Buy Campbell Soup

Speculation that Campbell Soup may be Warren Buffett's next acquisition target is swirling around the financial media. Many observers believe that Berkshire Hathaway's joint acquisition of Heinz could lead to the acquisition of other branded food companies -- and there are many reasons why it could be Campbell Soup.

Campbell Soup has the consistency and durability of PepsiCo
Everyone knows that PepsiCo is a great business, but few put Campbell Soup in the same league as the world's leading snacks company.

However, the evidence suggests just that. Campbell Soup may not have the global reach and worldwide name recognition that makes PepsiCo one of the world's most respected companies, but its financial performance suggests that there are many similarities between the two companies.

The following chart -- PepsiCo and Campbell Soup's operating margin for the last two decades -- illustrates the similarities.

Source: Mergent Online, author's calculation of adjusted operating margin (excludes one-time items)

The similarity between the two companies' operating margins through the years is striking. Both generate a remarkably stable operating profit from year to year and profitability has trended upward over the long term.

It makes sense that Campbell Soup and PepsiCo share similar profitability trends. For one, both have leading shares of their respective markets. Campbell Soup has a 60% share of the U.S. wet-soup market; PepsiCo has a 64% share of the U.S salty snacks market, a 40% share of the salty snacks market worldwide, and a 28% share of the U.S. carbonated soft drink market.

Companies that have a commanding share of a market tend to have pricing power, which enables them to increase prices faster than inflation. Both companies derive significant advantages from a portfolio of strong brand names -- which enables them to get prime shelf space from retailers -- and extensive distribution networks that enable them to efficiently supply stores worldwide.

The most important similarity between Campbell Soup and PepsiCo -- and the reason both companies are enduring -- is that both companies dominate industries that will be around for decades. People will always eat soup and Campbell Soup will still dominate the category in 30 years. The same is true for PepsiCo's brands -- people will still eat salty snacks and drink soft drinks.

Campbell Soup and PepsiCo's dominance of their primary markets is insurmountable. This is a key reason why Buffett may be interested in financing a Heinz acquisition of Campbell Soup.

Campbell Soup is clearly better than an average business like Macy's
It may be easier to see just how significant Campbell Soup's advantage is by looking at a company that does not have the same characteristics.

Macy's is well known in the U.S., but the company's profitability suggests its name recognition does not count for much. Although Campbell Soup's operating margin is mostly stable even during economic downturns, Macy's margin is much more susceptible to competition and economic slowdowns.

Macy's may have name recognition, but so do Target, J.C. Penney, and Sears. Name recognition is not a competitive advantage -- it is necessary to have in order to compete. People will always go to department stores, but they might not always go to Macy's or Bloomingdale's. Macy's does not dominate its industry. Campbell Soup dominates its industry.

Price is the primary consideration for Macy's consumers, so it is constantly battling competitors to offer the lowest prices or to bid for exclusive brands. This is a recipe for low margins and cyclical profitability -- the hallmarks of an average business that has no enduring competitive advantage.

What investors should make of the speculation
It makes a lot of sense for Heinz to acquire Campbell Soup; if for no other reason, they purchase similar raw ingredients and a combination would enhance the companies' purchasing power. But it is a fool's errand to buy a stock in the hope that it will soon be acquired.

Instead, investors should consider investing in Campbell Soup for the reasons Buffett might buy it: it generates a high margin on branded products that will always be in demand. If you are willing to buy and hold a high-quality company forever, then Campbell Soup may be worth looking into.

What else interests Warren Buffett?
Warren Buffett has made billions through his investing and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

The article Why Warren Buffett Might Buy Campbell Soup originally appeared on Fool.com.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.