The Drip Portfolio
Putting Heinz on our food and beverage list was my idea in the first place, because I thought the stock might offer the chance of an investment opportunity along the lines of Mellon Bank (NYSE: MEL). What's the resemblance to Mellon, you may be wondering? Sure, both firms are based in Pittsburgh, Pa., but that wasn't the rationale at all.
Rather, this portfolio started investing in Mellon at a key moment when the company was starting to transform itself into a newer and better business. At the same time, we thought the new-look Mellon was not getting its proper due in the marketplace. This created an opportunity to acquire shares in what we perceived to be a high-quality business at prices that were reasonable or, even better, at a discount to the company's actual value. We still think this is the case, more than a year after our initial investment. Great quality + reasonable valuation = BUY BUY BUY in our book. (Which is on sale at FoolMart, by the way.)
At Heinz, I initially thought a similar situation may exist. In a way, my hunch was well-placed. As Jeff discovered during his look at the company this week, there are indeed similarities between Heinz and one of the portfolio's holdings. Only the similarities aren't so much with Mellon as with Campbell Soup (NYSE: CPB).
If we've learned anything by way of our investment in Campbell, it's that we need to come up with our own growth assumptions when the future earnings picture starts to get a little bit fuzzy. We've also learned that it's not a particularly good idea to start Dripping into a company that will end up tacking on fees to its Drip plan a few months down the road, but that's another can of worms entirely. But by not taking a company's growth target as gospel and factoring in a decent margin of safety, we found out that investors can limit to a decent degree some of the risk that comes with making a long-term commitment to an individual company.
As a consequence, we don't believe that Heinz's 10% to 12% projected annual earnings growth goal under its Operation Excel amounts to a hill of Heinz Baked Beans. Heinz has done a tremendous job of building a great brand name for itself this century. However, it lacks the above-average earnings and revenue growth and above-average margins and profitability ratios that we see in the other food and beverage industry leaders that we've looked at. Without those attributes, growing earnings consistently by double-digits over the next 20 years in a mature marketplace could prove to be a big challenge for the company.
Still, we could possibly overlook all of these negative aspects if the stock was priced right. Here's how the price-to-earnings ratios for Heinz and our three finalists stack up using trailing 12 months earnings results:
Ticker Earnings Per Share (TTM) Trailing P/E
HNZ $2.45 19.2
WWY $2.59 34.4
KO $1.27 48.8
PEP $1.12 30.9
Heinz is trading at a hefty discount to our finalists, but is it enough of a blue light special to justify our money? Investing in a company with a low valuation can certainly make all the difference in the world, even when you are investing over a long period of time like we are. Stacked against our three finalists, it appears we can get all of the Heinz for half the price of our other food and beverage leaders. But is that enough of a margin of safety to warrant a long-term commitment? What about the lack of earnings growth? And what's with all of these rhetorical questions?
If you haven't figured out already from the above paragraph, I'm somewhat intrigued with Heinz's current valuation and would not be against spending some more time modeling what could happen to its share price in the future. However, I agree with Jeff that the company's business prospects over the next 20 years do not inspire the same level of confidence as those of our other finalists.
Instead of following my thumbs-down decision on Hershey (NYSE: HSY) from a few weeks ago with another quick dismissal, I'd like to put this valuation question to a vote on the Drip Companies message board. Should we spend more time studying the ketchup king, or should we move on and complete our food and beverage study sometime before the end of the millennium?
A simple "yea" or "nay" in a post titled "Keep the Ketchup Coming?" will do, but feel free to submit your views on the company's valuation as well. Since Monday is Columbus Day, we'll keep the polls open until Tuesday and share the results later next week.