Wednesday, February 22, 2006

Heinz and Peltz

I apologize for a dearth of activity in this blog for the last few days. I have been busy with the business, and had a lot of demands on my time. But finally, an opportunity to come up for air!

There was some speculation on CNBC yesterday, that Nelson Peltz was undertaking an activist role with H.J. Heinz Company (HNZ). As of today, no 13-D or proxy statement opposing management has appeared.


This follows a few days of considerable activity in HNZ options. Let’s look at the Heinz business.

No question that this is a collection of brand “icons.” Whether ubiquitous ketchup where HNZ controls 60% of the US ketchup market, OreIda, or Weight-Watchers Food, Heinz has many thousands of products versus the famous 57. The company has many products that seem to have been commoditized. The international efforts of HNZ seem to have been focused on traditional slow-growth economies such as the UK or Italy rather than Asian economies. There is a food service business that represents about 20% of relatively low-margin sales. On December 20, 2002, HNZ completed the spin-off of its underperforming U.S. and Canadian pet food and pet snacks, U.S. tuna, U.S. retail private label soup and private label gravy, College Inn ® broths, and its US infant feeding businesses to a subsidiary of Del Monte Foods Company. The company had a 16% stake in Hain Celestial which it recently sold. In my view, the worst of the businesses have been sold…what remains is a un undermanaged business that lacks focus.

From a governance standpoint, the company has an 80% super-majority vote requirement to make certain governance changes. Given its Pennsylvania incorporation and the PA legislative propensity to quash minority shareholder rights as demonstrated to Relational Investors recently in its lawsuit against Sovereign Bank (SOV), this could be a very nasty battle of pyrrhic proportions.

Pennsylvania Bill aids Sovereign

What has management done for you lately? Regrettably, from what I can ascertain, I am sad to report not much. All numbers are as of April 2005, the last complete fiscal.The company has generated CFFO over the last five years of $5.26 billion from continuing operations. They have spent about $1.7 billion in capex leaving free cash flow of $3.5 billion. Dividends over this period of time have totaled $2.4 billion and share buybacks (net of issuance) are $928 million. On a TTM basis, the ROIC is a fairly modest 10% but ROE is 34.4% due to debt leverage. Long term debt to equity is 240%! Long term debt to assets is 46%. Interestingly, the FCF for the TTM is negative. On an EV/EBIT basis for the TTM, the company is valued at 14.6 times.

How do these numbers compare with other packaged food companies? Kellogg (K) generates ROIC of 16.8% and a comparable ROE of about 36%. Campbell’s Soup (CPB) generates ROIC of 21.3% and an ROE of 52%. Even Hormel (HRL) with its heavy orientation to the tough meat processing business has a ROIC of 13.2%. Kraft (KFT) has managed to underperform HNZ with an ROIC of a modest 6.3%.

I would not care to speculate on the possibilities of takeover. The Commonwealth of Pennsylvania is not a shareholder friendly jurisdiction as I have already expressed. The low-hanging under-performing assets have already been plucked. Shareholder proposals to sell the company have been presented in prior proxies and to no avail. Returns on capital seem low relative to most other companies in this business. The company has a history of generating free cash flow, but hasn’t done so in the last twelve months. Finally, returns to shareholders in terms of dividends and share buybacks have pretty much equaled the FCF generated in the last five years. Short of recapitalizing the business, one cannot expect much more.

However, the real issue remains…can this business generate greater free cash flow if it is managed properly and more aggressively?

I suspect the answer is yes.


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