I really try not to fall into the Wall Street trap of always looking for something to complain about when looking at companies. To that end, I think Heinz (NYSE:HNZ) ought to get its due for its strong emerging markets position, its valuable market-leading brands and its ability to maintain respectable volumes in North America. Nevertheless, while Heinz is a solid enough long-term dividend play, I do believe that the company has to wring more profits from its sales for the stock to be worth substantially more than today's level.
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A Respectable Start to the Fiscal Year
By and large, Heinz got the fiscal year off to a good start. While the bottom line performance wasn't quite as strong as it may first seem, the company is doing reasonably well despite some pressures in its large frozen foods business. Revenue dropped 2% as reported, but rose almost 5% organically on an even split between volume and price. Heinz's top brands fared relatively better (up almost 6% organically), while emerging markets continue to provide strong growth (19% organic). Oddly enough, Heinz's North American results were the weakest on an organic basis; up just 1% as the company held back from substantial price hikes.
Margins were OK, but not spectacular. Gross margin rose 10 basis points on an adjusted basis, while reported adjusted operating income was basically flat. While currency-adjusted operating income did rise about 5%, that still is not much incremental margin leverage. All in all, while the company reported a seven cents beat, five cents of that came from a lower tax rate.
SEE: A Look At Corporate Profit Margins
International Still a Driver
Relative to food giants like Kraft (Nasdaq:KFT), Unilever (NYSE:UL) and Nestle (OTC:NSRGF), Heinz compares pretty favorably in terms of its international exposure, particularly in emerging markets. Unfortunately, while Heinz does provide an above-average level of financial detail, it doesn't give quite enough information to back up how much of its emerging market growth is due to the fast-growing infant nutrition market; a market where companies like Nestle, Mead Johnson (NYSE:MJN) and Danone are seeing significant growth.
Either way, Heinz is building and supporting a business that could pay rich dividends down the road. The company is giving more ad support to its Quero brand in Brazil and piggybacking that with more product introductions and promotions for sauces like ketchup in Brazil. While that costs dollars (and margins) today, it could establish a moat that rivals like ConAgra (NYSE:CAG) will struggle to cross later.
SEE: Investing In Brazil 101
Frozen Still Needs Fixing
Frozen foods remains a good news-bad news situation for Heinz. The bad news is that Heinz continues to see volume erosion, even when adjusting for discontinued lines (like some TGI Friday's products). The good news, such as it is, is that the category as a whole is pretty weak and while ConAgra and Tyson (NYSE:TSN) are outperforming Heinz, they're not really running away with the market. I do wonder, though, about Heinz's long-term plans. While Heinz seems content to get smaller, ConAgra and Tyson seem to be going the other way - with ConAgra recently buying Unilever's North American frozen meals business and Tyson continuing to develop additional frozen packaged food offerings.
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The Bottom Line
From a quality perspective, I like Heinz just fine. Moreover, I think the company's focus on emerging markets is going to pay off down the road as there's simply more growth potential in emerging markets packaged food sales than in North America. All of that said, Heinz is no undiscovered stock and the stock's multiples reflect this. Free cash flow growth of 5 to 6% suggests a fair value in the high $50s - a target that is arguably good enough to make Heinz a hold for long-term investors (particularly those looking for decent dividend growth names), but not really very compelling for new investors looking for undervalued names to buy.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.