One Stock Always Playing Ketchup

09/22/2011 8:30 am EST

Focus: STOCKS

This solid income pick is the most globally diversified packaged food firm based in the United States, with 60% of total revenue from abroad, says Erin Lash of Morningstar DividendInvestor.

While, above anything else, Heinz (HNZ) is known for its ketchup, the firm’s products span several categories beyond the condiment aisle, including sauces, soups, baked beans, baby food, and frozen foods.

Heinz is focused on expanding in emerging markets, which already account for 16% of sales. Through a combination of internal growth—like expanding its launch of infant formula in China—and acquisitions, management is targeting a contribution from these high-growth areas of around 30% of total sales by fiscal 2016, which appears achievable to us.

Rising commodity costs continue to plague packaged food firms, and Heinz is no exception. From our perspective, there is only so much that today’s fragile consumer is going to be able to absorb—especially where unemployment levels remain stubbornly high, wage growth is lackluster, and gas prices are on the rise.

However, we remain impressed by Heinz’s laser focus on driving costs out of the business, which should help preserve market share without having to resort repeatedly to expensive promotional spending.

Heinz’s dividend-payout ratio, which we estimate at 59% for fiscal 2012 (which ends in April), has typically been at the high end of its peer group. This has not always been easy; in 2003, the dividend was reduced by one-third in conjunction with the spin-off of Del Monte.

The firm’s financial performance has improved substantially since then, and a shift in currency trends (a strengthening US dollar in the 1990s, a weakening one since) has helped as well. Overall, we are comfortable with the safety of the dividend as well as the firm’s financial position (Heinz earns a Morningstar credit rating of A-).

Management recently raised its long-term outlook for per-share earnings growth by 1 percentage point, to 7% to 10% per year. We’re comfortable with the bottom end of this range, and expect the dividend to track earnings growth closely.

Over the next five years, we anticipate a 4% growth rate for revenue, giving credit to Heinz’s large overseas footprint as well as the relative maturity of most of its markets. We also see some potential for small gains in profit margins, reductions in interest costs, and a contribution from modest share buybacks—each factor accounting for roughly an extra percentage point of growth per year.

Heinz could be a compelling purchase around $42, which would position the stock to yield a handsome 4.6% and provide long-run total returns averaging 11% to 12%.

However, given the firm’s hard-to-control exposures to currency changes and commodity prices, we believe holding out for a moderate margin of safety is appropriate. [HNZ was falling but still above $50 in midday trading Wednesday—Editor.]

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