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Tickers in this Article: HNZ, KFT, UL, CAG, CPB
H.J. Heinz (HNZ) had been suffering from falling margins and over-expansion.

Despite being a large global packaged food company, HNZ has been impacted by high commodity, packaging and distribution costs.

HNZ had also been suffering from a problem of the sixties.

HNZ has 15 brands that account for about 66% of sales. HNZ, also receives 60% of its sales from international sources.

While the international sales in themselves are not a problem, of that 60%, about 67% of those sales were in Europe, and HNZ was being impacted by tighter margins and weaker sales in those markets.

Enter in early 2006, Trian Fund Management, an activist fund that acquired a 5.4% stake in the company, began seeking to create value at HNZ by gaining board seats.

HNZ immediately embarked on a new strategic vision and a plan for building shareholder value.

The basic tenets were to increase sales growth 3-4%, increase operating income and EPS growth in the 6-8% range and produce operating free cash flow of $800-900 million. HNZ began to re-focus on its core brands and began to divest non-core brands in Europe. Concurrently, HNZ began an aggressive campaign to launch 200 new products and increase its marketing expenses 20% in attempt to bolster sales of those products.

At the moment, it appears those efforts are beginning to pay off.

HNZ has 160 brands that hold #1 or #2 market positions. The divestiture of about 20 non-core product lines, primarily in Europe, generated about $1 billion, approximately 25% of which HNZ will use to repurchase shares.

Now, approximately 90% of sales, up from 80%, will be in core categories and 60% of sales will be from in HNZ's top 10 brands. This move will lift sales and margins for HNZ. HNZ's growth will also be aided by their market leading presence in the burgeoning economies of Russia, India, China, Indonesia and Poland.


All in all, the fruits of the company's labors are beginning to take hold. Heinz will release its third quarter's earnings on Tuesday. Sales growth is expected to be a robust 5%, which is expected to drive growth in operating profit in the range of 9%, translating into 30% growth in earnings per share.

Management is comfortable with full year earnings guidance of $2.35-2.39 per share, a 12-14% annual increase. Heinz believes it can achieve these levels, as it anticipates global supply chain savings of $175 million this year, $10 million higher than planned, exiting 15 plants and incremental savings in it SG&A budget. As well, HNZ expects to have repurchased almost $1.4 billion worth of shares, reducing its outstanding stock by nearly 8.5%.

One additional factor that may work in HNZ's favor is the consolidation in the food sector.

Despite its many market-leading brands, HNZ is dwarfed in size by other industry entrants like Kraft (KFT), Unilever (UL) and Nestlé. Heinz is most comparable in size and valuation to ConAgra Foods (CAG) and Campbell Soup (CPB), which may also be targets.

Heinz, with its re-focus on shareholder value is more attractively priced than CAG or CPB, in terms of P/E ratio and dividend yield, while on an EV/EBITDA basis, the three companies are approximately equal.


A buyout of any of these three food companies may not come to pass, but HNZ is now well-positioned in comparison to its peers. Additionally, Heinz is expected to generate $700-900 million in free cash flow this year, which can be used to increase its dividends and repurchase stock. Overall, Heinz's improving fundamentals and reasonable valuation make it a wise addition to your portfolio.

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