H.J. Heinz (NYSE:HNZ)
Trading at $37.22 as of 2/9/05

This article is part of our annual Stocks Fools Love Valentine's Day Special.

Everyone knows the name of this company, which is why its namesake brand alone is externally valued at around $8 billion and enjoys an astounding 70% share of the U.S. market. I'm talking, of course, about condiment connoisseur H.J. Heinz. This firm's shares have risen only modestly since I recommended them in the pages of Motley Fool Income Investor several months ago, which means plenty of opportunity remains.

If you're not familiar with its premiere product, Heinz Tomato Ketchup, I hope you've enjoyed the comfort of your cave for the last 135 years. For the rest of us, this company exemplifies what building a successful brand is all about.

Heinz is known for far more than just ketchup -- which we'll discuss momentarily -- but this product deserves some focus because it epitomizes what the company does better than anyone else: brand domination. Its share of the U.S.'s ketchup market has grown from about 50% to just more than 70% in the last few years. That's a 40% increase in market share for a very, very mature brand.

Certainly it's remarkable that Heinz makes nearly three-quarters of the ketchup consumed worldwide, but let's think about the significance of this accomplishment. It's not like we're talking about semiconductors or something that dominates through superior technology. We're talking ketchup, a.k.a. squished tomatoes. Seventy percent is an amazing figure for any product, but it's virtually unheard-of for one that's effectively a commodity.

This company is a testament to the power of a quality brand, not to mention innovative marketing and value-added product development. What does a firm do when the distinction between its product and its competitor's ketchup blurs and market share suffers? If you're Heinz, you turn your ketchup green, or pink, or some other crazy color that's terribly appealing to kids who like nothing better than to gross out their parents. I swear I remember Tom Brokaw talking about green ketchup on the news the day it was released, and that, ladies and gentlemen, is effective marketing and product development.

After spinning off several brands to Del Monte Foods (NYSE:DLM) in December 2002, Heinz is left with a core portfolio of quality offerings. It sells consumer food products such as soups and meats, frozen snacks, pastas, and ready-to-eat meals under brand names Ore-Ida, Bagel Bites, Rosetto, TGI Friday's, and Weight Watchers. The company now has the leading or second-place brand in more than 50 countries worldwide.

By the numbers
Heinz hasn't been able to relish its relish lately. CEO Bill Johnson took the helm in 1998, and the Heinz veteran immediately began implementing numerous changes in order to turn the bloated, poorly disciplined conglomerate around. It's taken some time to get this ship moving in the right direction, but Johnson -- and the new managers he's brought on board -- seem to be getting the job done.

A key accomplishment has been streamlining the brand structure around its most dominant international products. (Sixty percent of revenue now comes from outside the U.S., 15% of that from the rapidly expanding Chinese market.) Most impressive so far is the company's return to fiscal discipline. Free cash flow (FCF) has been growing by leaps and bounds even as its balance sheet strengthens. Long-term debt as a percentage of total capital has fallen from nearly 60% to the current 33% over the past year -- an impressive run. This, along with Heinz's near $1.3 billion cash position, has it on better financial footing than most of its peers.

I believe Heinz is finally on the path to producing consistent earnings growth, which should be in the 9% range over the next five years. It has improved its operating margin to 16.4%, and though future improvement will come at a slower pace, any unanticipated surge could lead to double-digit earnings growth and a higher valuation.

Shares of this condiment master have risen about 4.5% during the past 12 months, but that still leaves them trading below where they were five years ago. On the bright side, the stock's lack of oomph has resulted in shares trading at just 14.6 times earnings, 14 times FCF, and a paltry 11.3 times operating cash flow. Based on a blended discounted cash flow and peer analysis, I peg Heinz's shares at $41. That's a nice discount when you consider the sweet and tangy 3% dividend yield.

The Foolish bottom line
Product innovation -- coupled with an apparent knack for developing superior taste -- has led to world-dominating market share for both Heinz's well-known ketchup brand and its now-efficient product portfolio. The company possesses rapidly improving business fundamentals and a management team with the foresight to continue its successful climb.

In addition to taking down gallons of ketchup in his spare time, Mathew Emmert is the chief analyst of the Fool's dividend-oriented newsletter, Motley Fool Income Investor . He owns no shares of the companies discussed in this article. The Fool is investors writing for investors.