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Emerging markets spicing up H.J. Heinz's shares

The way to release the ketchup faster from the Heinz Ketchup glass bottle is not to whack it on the bottom but to apply a firm tap to the spot on the neck where the famous '57 Varieties' decal appears.

"Only 11 per cent of people know this secret," says the website of Pittsburgh, Penn.-based H.J. Heinz Co. , a 147-year-old company.

As for the '57 Varieties' slogan, it doesn't refer to 57 varieties of ketchup as many people assume, but to the approximate number of products Heinz made in 1896 when the slogan was invented. Nowadays, the company manufactures and distributes over 5,000 packaged-food products including bottled sauces, frozen foods, dried soups, canned beans, pasta meals, and infant formulas.

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So, what to make of a company whose flagship product and corporate slogan have been somewhat misunderstood for over a century? And what about the private-label products grabbing shelf space in stores these days, not to mention the 10-year stock chart showing a flat line (after smoothing out the hills and valleys)?

Looks like another one of those sclerotic companies your portfolio should avoid, right?

Not according to several equity analysts highly rated in StarMine Corp.'s survey of brokerage analysts.

They have buy recommendations on the shares, mainly because the company's expansion into emerging markets is hitting its stride under the leadership of chairman, president and CEO William R. Johnson and the watchful eye of activist investor Nelson Peltz of Triarc Companies Inc. Then there is the solid and rising dividend, paying 3.7 per cent.

Growth heating up thanks to emerging markets

The pick-up in emerging-market sales, one of the best on display within the packaged-food industry, comes just in time to offset difficult conditions in the U.S. market. Domestic demand reached a saturation point long ago, but now company margins are coming under pressure: prices for corn, wheat and other crops have soared to record levels in 2011 while the ability to raise consumer prices remains constrained by high unemployment and collapsing house prices.

As Credit Suisse analyst Robert Moskow notes: "We think investors who seek a relative safe haven should invest in names with better exposure in emerging markets." And as Deutsche Bank Securities analyst Eric Katzman told, "You want companies that have emerging market exposure because that's where there is volume growth."

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The contribution of emerging markets - where the middle class and appetite for Western goods is on the rise - can be seen in Heinz's recently released financial results for the third quarter. Total organic sales (adjusted for the impact of acquisitions) increased by 1.7 per cent to $2.7-billion (U.S.) over the same quarter a year ago, thanks to a major assist from a 14-per-cent advance in organic sales within emerging markets (constant-currency basis). This extends the streak of revenue increases to the 23d quarter.

Net income climbed 20 per cent and boosted earnings per share to $0.84 (U.S.), the fifth quarter in a row Wall Street estimates have been beaten. "Profits were primarily driven by emerging markets, backed by strong performance of … nutritional beverages in India, ABC branded products in Indonesia, Heinz-branded products in Russia and Heinz infant-nutrition products in China," observed a report from Zacks Investment Service.

Reaction to third-quarter results was positive. Citing encouraging growth in emerging markets, Citigroup analyst David Driscoll raised his price target from $54 (U.S.) to - what else - $57 (U.S.). Two other analysts, Terry Bivens at J.P. Morgan and Christopher Growe at Stifel Nicolaus, reaffirmed their respective "overweight" and "buy" ratings.

With international markets accounting for 60 per cent of sales, Heinz is the most globally diversified of U.S. packaged-food firms. But there still appears to be lots more growth ahead considering emerging markets make up only 16 per cent of total sales and management is targeting 30 per cent by fiscal year 2016.

In addition to organic growth, Heinz sees a contribution from acquisitions. A recent highlight was the all-cash purchase of S.A. Industrias Alimenticias, a company with leading tomato-sauce and ketchup brands in Brazil. In November, a Chinese maker of soy sauce was acquired.

Spinning off free cash flow at a rate greater than 10 per cent of sales, Heinz has the financial means to buy other companies. It also has the opportunities: "I have never seen more merger and acquisition opportunities in emerging markets than I am seeing now," said Mr. Johnson at a conference in February.

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Another positive sign is the company's ongoing emphasis on product innovation and development. The upside-down ketchup bottle was a great success. Management is hoping for a similar score with the Dip & Squeeze package, an improvement on the single-serve ketchup packet found in restaurants everywhere.

Packaged-food companies encountering less price inflation in the crops they buy may attain better financial results than their peers, as hedges and purchase agreements expire. Such could be the case for Heinz. Its main commodity inputs of tomatoes and potatoes have not been afflicted with price run-ups to the same extent as corn, wheat and other crops. As Mr. Moskow writes, "Heinz has limited exposure to commodity inflation."

An appetizing dividend

While there are more exciting growth stories in other industries, they don't usually come with a dividend yielding 3.7 per cent. This income stream looks well supported - the payout ratio is close to 58 per cent. Furthermore, given Heinz's growth dynamic, it wouldn't be surprising to see dividend hikes continuing at the average annual rate of 7.5 per cent realized since 2003 (when the dividend was cut).

The combination of a solid dividend, brand-name pricing power, growth, and stability of the food industry over the business cycle may be of interest to investors seeking companies for the defensive and/or income portion of their portfolio.

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