JUPITER, FL (Oct. 7, 1999) -- In February of this year, H. J. Heinz (NYSE: HNZ) unveiled its Operation Excel program. The program is a transformative growth and restructuring initiative that "could generate in excess of $200 million in annual pretax savings and growth in earnings per share of 10 to 12 percent."

The program is multiyear and multifaceted and it will result in restructuring charges and implementation costs approaching $1.1 billion over four years. The program involves reorganizing, consolidating, cutting staff, and closing up to 20 factories worldwide. At the same time, the program involves aggressively marketing leading products, developing new products, expanding markets for current products, and entering new markets.

According to Heinz's chairman, 20 years ago only 15% of the world knew the Heinz brand. Today the company has leading products selling on every inhabitable continent. This is an impressive accomplishment, and much of the success came in the past 10 years. It makes me ponder, however, the following question.

If sales have grown only 58% in the past 10 years (while many leading beverage and food giants have more than doubled sales over the same time), and those 10 years were an exceptional growth period, how can Heinz top it in the next 10 years? The Drip Port hopes to see double-digit sales growth annually (aggressive -- we know), which means that a company should at least double its sales about every eight years. So, sales should grow by over two-and-a-half times while we own a company, because we have 20 years to meet our investment goals.

In fiscal 1999, Heinz grew revenue 1% on a 3.2% sales volume increase. The year prior, sales volume grew 3.1% while revenue declined due primarily to divestitures. Revenue has been flat for the past four years, but restructuring charges have impacted the figures. Even without charges, however, sales have not grown anywhere near double digits annually. Operating profit has done better. Heinz grew operating income 9.6% in fiscal 1999 when ignoring one-time restructuring charges.

That's history. We're most concerned with where the company is going, or could go.

Operation Excel is a great initiative to cut costs and improve the company's performance potential, but given the company's recent performance, I'm cautious about accepting the 10% to 12% EPS growth goal given by management. Campbell Soup (NYSE: CPB) made a bold attempt for the same type of figures, or higher, but it has failed thus far while having just one primary business to prop higher (whereas Heinz has 5,700 products sold in over 200 countries). So, I can't model for long-term (10 years or more) earnings growth of 10% to 12% without rose-tinted glasses and a lot of share buybacks. Analysts slap a 10.6% EPS growth number on Heinz for the next five years. I think that's a joke. They're just listening to management. Management hasn't delivered as well as I'd like to see, however, even during its great 10-year period.

Call me a skeptic and an old fuddy duddy ("Hey old fuddy duddy!"), but I do keep an eye on a company's book value over the long term, especially for these old giants that, when managed well, should be able to continue to build lasting equity for shareholders on an annual basis. Wrigley (NYSE: WWY) and Coca-Cola (NYSE: KO) have ended each year with a higher book value almost every single year for the past 12. Heinz's book value was $4.62 per share in 1989. It ended at $5.02 this year. Over the past 10 years, its highest point was $7.34, in 1994.

More important than book value is how much money the company is cranking out for every dollar put into the business. Here we see a general decline in ROIC the past 10 years. However, management says it will rise from here, and there is reason to believe them.

Pretax return on average invested capital (ROIC)
1999   20.8% 
1998   27.0% 
1997   12.6%
1996   21.8% 
1995   22.1% 
1994   22.7% 
1993   18.7% 
1992   28.8% 
1991   31.3% 
1990   31.3% 
1989   31.4% 
Meanwhile, return on shareholders' equity (ROE) has held steady for the most part.

Return on average shareholders' equity (ROE)
(before the cumulative effect of accounting change last year)
1999   23.6% 
1998   34.4% 
1997   11.7% 
1996   25.5% 
1995   24.6% 
1994   25.9% 
1993   22.0% 
1992   27.5% 
1991   27.3% 
1990   27.5% 
1989   26.1% 
With ROIC of 20.8% last year and 27% the year before, Heinz is covering its cost of capital with room to spare, even though it lags our contenders. The following is how Heinz compares to our three finalists on key measures for the last complete year:
                KO      PEP     WWY     HNZ
ROE             35.0%   31.7%   28.4%   23.6%
ROIC            31.2%   23.0%   24.5%   20.8%
Gross Margin    70.4%   57.3%   57.7%   36.1%
Oper. Margin    26.4%   12.9%   20.6%   11.7%
LT Debt/Equity  0.12    0.38    0.00    1.96
Heinz is tightly enough run that it is on track for eventual gross margins of about 40% if Operation Excel pans out, which would be up from 36% last year but still lag our other companies.

I'm of the mind to drop Heinz from the contest as we did two years ago because it has been failing on many of our good ole investment criteria, including double-digit annual sales and earnings growth, consistent double-digit net profit margin (Heinz's was just 5.1% last year), and a strong balance sheet. Heinz had $2.4 billion in long-term debt and $115 million in cash to end fiscal 1999. In comparison, our three finalist companies meet all of our eight criteria except for double-digit sales growth, and there the companies have generally have done much better than Heinz (except for Coca-Cola).

As respected as Heinz is (and for good reasons), and as promising as its new Operation Excel program appears, it isn't a 20-year plan to grow as a dynamic company. It is more of a several-year plan to save money and address and expand all possible markets. An example of the potential to expand markets given from management was "If people in Switzerland enjoy pasta with ketchup, why shouldn't people in America? Americans just need to learn about it."

Yeah, sure, maybe. I wouldn't bet 20-year's worth of consistent investments on it, however -- especially not while hoping to crush the market with the stock. The amount of people who will learn to love eggs or pasta with ketchup isn't that large. Brian, for example, already puts ketchup on everything that he eats, and even in his drinks, including milk and Coca-Cola. He's a liability on Heinz's balance sheet. If he stops liking ketchup, look out.

I vote for keeping Heinz in the bottle and off our list. We'll see what Brian thinks when he's able to write about Heinz tomorrow or next week. To discuss the company, please visit us on the Drip Companies board!

Fool on!