Is This High-Yield Blue Chip Worth Your Time?

By Demitri Kalogeropoulos - September 4, 2012 | Tickers: CPB, GIS, HNZ, KRFT | 0 Comments

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H.J. Heinz's (NYSE: HNZ) shares touched a new high last week after the company reported its 29^th straight quarter of organic sales growth. The Ketchup King delivered higher profits too, aided by strong growth in emerging markets. But the stock’s rich valuation and rising debt levels has a lot of investors wondering if the market is charging too much for this sauce-maker and its 3.7% yield.

At 19 times earnings, is an investment in Heinz really worth the risk? Or, to paraphrase a line from the movie The Girl Next Door, "Is the sauce worth the squeeze?"

The Sauce

To try to answer that question let’s start with the good stuff; what investors are getting for their investment in Heinz. The short answer is: a lot.

Considering its perch as a premium brand food company in times of consumer cutbacks and commodity inflation, Heinz has performed well. The company's sales, profits, and dividends have been steadily increasing over the past 5 years.

Sales are in 000's.

Key to that growth has been strong sales of Heinz's flagship ketchup and sauce brands. But on top of that solid foundation the company has also been booking more revenue from emerging markets. Heinz went on an international shopping spree in 2011, scooping up big brands in both the Chinese and Brazilian markets. China and Brazil now promise to become major markets for Heinz down the line. And the company's spicy 19% sales growth in emerging markets last quarter shows those investments already beginning to pay off.

At the same time, Heinz is dropping underperforming products -- like TGI Friday's and Boston Market licenses -- in a bid to refocus on top brands in its portfolio. And this stronger brand position has translated to increased pricing power for Heinz, as it raised prices by 3.8% last year with only a 0.3% drop in volume. By comparison, General Mills (NYSE: GIS) and Campbell Soup (NYSE: CPB) couldn't manage that feat; their price hikes were met with volume dips of 6% and 1%, respectively.

Altogether, Heinz' strong execution has delivered impressive global sales growth. That growth powered over $1 billion in annual free cash flow and easily funded a 7% hike in dividends paid to shareholders.  

The Squeeze

So what are investors risking in exchange for a piece of that solid business execution? The short answer here is: debt and write-downs.

To fund the major Brazilian and Chinese expansions, debt levels at the company have ticked up. Total debt rose from $4.6 billion in 2011 to just over $5 billion last year. And on top of increased debt payments, Heinz has been forced to take a series of charges to profits as it writes down past investments that didn't turn out as planned. Taken together these points raise the concern that Heinz could be stuck in a poor expansion cycle, with sales gains from good investments being continuously offset by write-downs in the bad ones.

As far as price goes, Heinz isn't nearly as cheap as it used to be. But the company doesn't seem so richly valued when compared to other consumer food staples like Kraft (NASDAQ: KRFT) and General Mills.

HNZ PE Ratio data by YCharts

Bottom line

Overall, Heinz looks like a great investment to me. The company boasts pricing power and has shown that it can deliver sales growth in a tough economic environment. Management is executing well and delivering steadily increasing returns to shareholders. Best of all, Heinz's strong cash flows and sector-beating yield don't appear completely priced in to the shares. 

If Heinz' management can keep its recent focus on core brands, profitability should improve and investors stand to reap big rewards in the form of expanding global sales and margins. Buying into this ketchup and sauce maker isn't without its risks, but it's an investment that seems well worth the effort.

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