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Investing mainly in well-established companies is one of the three cornerstones of our investing philosophy (the other two are spreading your money out across the five main economic sectors, and focussing on investments that are outside the current media/broker limelight).
Well-established companies generate enormous gains over periods that stretch into decades. But their pace of growth varies. They can and often do swing back and forth between stagnation and explosive growth. But even during lackluster times, they build their potential for gain, and pay dividends.
H.J. HEINZ COMPANY $35 (New York symbol HNZ; WSSF Rating: Above average) rose more than 25-fold from the early 1980s through 1998. In the next couple of years, it dropped by nearly half. It has spent much of the current decade between $30 and $40. Its next big move is likely to be upward.
Heinz is one the world’s biggest food companies, with sales in over 200 countries. It’s best known for its Heinz ketchup, which has 60% of the American retail market and 80% of the restaurant market. Other products include soups, beans, pasta sauces (Classico), frozen potatoes (Ore-Ida) and baby food (Plasmon). Overseas markets account for 55% of Heinz’s sales, and 45% of its profit.
Heinz’s sales fell from $9.4 billion in 2000 (fiscal years end April 30) to $8.2 billion in 2002, after it spun off several slow-growth brands such as North American tuna and pet food to Del Monte Foods Inc. Sales improved to $8.9 billion in 2004.
Earnings before unusual items fell from $2.55 a share (total $903.7 million) in 2000 to $2.03 ($713.4 million) in 2002, but rose to $2.20 ($778.9 million) in 2003, and to $2.34 ($827.7 million) in 2004.
Heinz now aims to enhance its long-term prospects with a new restructuring plan, centering on its international businesses, especially in Europe, which provides 40% of its sales. It hopes to improve its sluggish European operations with major acquisitions.
In August 2005, it paid $874 million for HP Foods Group, which owns the HP steak sauce and Lea & Perrins Worcestershire sauce brands. The purchase came with a perpetual license to market the rapidly growing Amoy soy sauce brands in Europe. These businesses add $300 million to Heinz’s annual sales.
The company plans to unload its less profitable European operations, mainly seafood and frozen foods, for around $1.4 billion. That would cut Europe’s contribution to Heinz’s sales from 40% to 30%.
Heinz also plans to sell its New Zealand poultry business (although the recent discovery of avian flu in Asia could delay any sale). The company also aims to sell its 17% stake in The Hain Celestial Group, Inc., which makes organic foods. These shares are currently worth about $135 million.
Thanks to the HP acquisition, sales in Heinz’s second fiscal quarter ended October 26, 2005 rose 6.4%, to $2.34 billion from $2.2 billion a year earlier. Income from continuing operations fell 10.7%, to $0.50 a share (total $171.8 million) from $0.56 ($199.0 million) a year earlier. However, the latest quarterly figure included $0.12 a share in restructuring charges.
The company is gaining from the fading popularity of low-carb diets. North American sales rose 10%, mainly due to stronger demand for frozen potato products and pasta sauces.
As part of its new growth plan, Heinz plans to spend more on marketing in the next years, while updating its marketing to reflect scientific findings. It particularly wants to emphasize the health benefits of tomato products, ketchup included, since tomatos seem to cut the risk of certain types of cancer and heart disease.
Heinz also hopes to spur sales with new pricing that will encourage the purchase of larger sizes. It also hopes that new packaging, such as child-sized plastic squeeze bottles with special nozzles, will spur ketchup consumption.
Heinz has another growth opportunity in developing countries, where expanding prosperity should spur big demand for its products.
The company recently paid an undisclosed sum for a controlling stake in Russia’s leading condiment maker. It may make similar investments in China, India and Indonesia in the next few years.
Foreign expansion hurts Heinz’s current earnings, particularly during periods when the U.S. dollar is rising against other currencies. But the company tempers this risk with currency hedges.
The company borrowed nearly $1 billion to finance its recent acquisitions. That increased its long-term debt, from 1.6 times equity at the end of fiscal 2005 to 2.4 times at October 26, 2005. But cost cuts from its restructuring plan should leave it with more cash to pay down debt.
The new acquisitions also increased Heinz’s goodwill by a third. It now stands at 25% of total assets. This increases the risk of a big writedown if these new operations run into trouble.
But that is an acceptable risk in light of the high quality of the new businesses, particularly HP and Lea & Perrins. They can feed on Heinz’s proven marketing strengths.
The stock has made little progress since the Del Monte spin off three years ago, but its growing portfolio of strong brands improves its long-term earnings potential. It’s still attractive at 14.9 times the $2.35 a share it should earn before unusual items in fiscal 2006.
It’s also appealing at 11.1 times its projected cash flow of $3.15 a share, and at 1.3 times its sales of $27.37 a share. The $1.20 dividend yields 3.4%.
Heinz is a buy for growth and income.
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