The 100 Best Stocks You Can Buy 2012 Part 19

Reasons to Buy.

Grainger is far and away the biggest presence in the MRO world. Their only broad-line compet.i.tor is one-quarter their size and the rest of the market is highly fragmented (Grainger has 45 percent market share). They also have the deepest catalog by far. It's estimated that 40 percent of purchases in the MRO market are unplanned, so having the broadest inventory and having it in stock is a big advantage for Grainger.

Even with its size and scope, the company estimates that it has only 4 percent of the U.S. MRO market, leaving a large growth opportunity. International sales are less than 20 percent of the total, and Grainger has established only a foothold in Mexico, China, j.a.pan, Korea, Columbia, and Puerto Rico with less than 1 percent of those markets. The company has a larger presence in Canada. Especially with so much manufacturing relocated overseas, the international opportunity looks rich for Grainger.

The share repurchases and dividend increases reflect a better-than-average orientation to shareholder value, and shareholder value is indeed one of the stated goals of the company. We find it refres.h.i.+ng to see it not only stated but also delivered upon.

Reasons for Caution.

Grainger will always be vulnerable to economic cycles and manufacturing displacement, especially so long as it remains concentrated on U.S. soil. International expansion will help alleviate this concern. Over the past five years, the share price has reflected most of the good news, mandating either careful price shopping for the stock or reliance on incremental growth opportunities in the United States and especially overseas market share.

AGGRESSIVE GROWTH.

Harris Corporation.

Ticker symbol: HRS (NYSE) S&P rating: BBB+ Value Line financial strength rating: A Current yield: 1.9%.

Company Profile.

Harris is an international communications and information technology company serving government and commercial markets in more than 150 countries. Founded in Ohio in 1895, the company was primarily a supplier of printing equipment until the mid-1950s when it began to focus on electronics. Over the next two decades, the electronics segment grew much faster than the print segment, and the company exited the printing business entirely in 1983. Now headquartered in Melbourne, Florida, the company has over 15,000 employees, including nearly 7,000 engineers and scientists. Harris develops communications products, systems, and services for global markets, including government communications, broadcast communications, and wireless transmission network solutions.

Its major business units include: Government Communications Systems conducts advanced research studies, develops prototypes, and produces and supports communications and information systems for mission-critical applications for military and government customers. These activities also provide a research base for commercial products and services. GCS accounts for approximately 50 percent of revenue.

RF (radio frequency) Communications supplies tactical radio communication products, systems, and networks to military and government organizations, and provides high-security encryption solutions. These solutions address the requirements of U.S., NATO, and Partners.h.i.+p for Peace forces, as well as government agencies and emba.s.sies around the world. RFC accounts for approximately 40 percent of revenue.

Broadcast Communications provides content delivery solutions, including advanced digital transmission, automation, a.s.set management, digital media, network management, and video infrastructure solutions to commercial broadcasters in radio, television, and digital satellite broadcast markets. BC accounts for approximately 10 percent of revenue.

In total, government contracts, sales, and services account for about 51.5 percent of FY2010 revenue.

Financial Highlights, Fiscal Year 2010.

After a lackl.u.s.ter FY2009, reflecting a divest.i.ture and some onetime goodwill impairment, Harris's FY2010 performance returned to a growth track, albeit with revenues still slightly off 2008's peak. FY2010 revenues came in at $5.2 billion, up about 4 percent from FY2009, while earnings per share climbed to $4.48 from $3.87, reflecting among other things an improvement in operating margins. FY2011 projections call for a healthy increase in revenues and per share earnings, to $6 billion and $4.85 respectively.

Reasons to Buy.

Over the past five years, Harris has doubled its share of the ground-based tactical radio market to 42 percent. This is a $3.8 billion dollar worldwide market that is growing at 11 percent per year. Current backlogs still reflect a substantial business in this segment.

The RF addressable radio market, currently valued at $8 billion, is expected to grow to nearly $18 billion in calendar year 2012, of which Harris's current and planned products are expected to cover over 90 percent.

The company has been able to capture sales in foreign markets, notably in Australia and Pakistan, adding new business to a fairly solid U.S. base. The company has been able to translate acquisitions and design wins into income at an impressive rate. Over the past five years, Harris's earnings compound annualized growth rate (CAGR) is a healthy 35 percent, and products introduced in the past three years have revenue CAGR of 49 percent.

The company has great cash flow (up 8 percent in FY2010 after rising 12 percent in FY2009) and a sound capital structure. In addition to funding nearly $1 billion in R&D in 2009 ($250 million internal, $750 million under government contract), the company continues to buy back shares and has repositioned themselves as a bit of an income play with an $.88 dividend, up from $.44 in 2007 and $.32 in 2006. They're well positioned for their acquisition plans and will continue to repurchase shares and boost dividends.

In June 2009, the company rejected preliminary buyout offers in the neighborhood of $10 billion, saying that it was under an expected offer of $75$85/share.

Reasons for Caution.

Questions remain about the eventual value of the F-35 strike fighter contract. Actual delivered quant.i.ties may be far lower than originally discussed. Harris is the prime contractor for three of its avionics and communication subsystems, with a projected value of $4 billion over the life of the program. The company is, and always will be, vulnerable to cuts in defense spending.

GROWTH AND INCOME.

H.J. Heinz Company.

Ticker symbol: HNZ (NYSE) S&P rating: BBB Value Line financial strength rating: A+ Current yield: 3.8%.

Company Profile.

H.J. Heinz Company manufactures and markets food products such as condiments and sauces, frozen food, soups, desserts, entrees, snacks, frozen potatoes, appetizers, and others for consumers and commercial customers. The company's best-known product, its ketchup, has a 60 percent market share in the United States, 70 percent in Canada, and nearly 80 percent in the United Kingdom. Condiments and sauces (including ketchup) account for approximately 42 percent of the company's revenue, with meals and snacks producing 45 percent, and Infant/Nutrition making up the remainder. Ore-Ida frozen potato products, Cla.s.sico pasta sauces, and SmartOnes meals are among the more well-known Heinz brands.

The Heinz portfolio includes 150 brands that hold the number one or number two market share positions in their categories, with presence on five continents and in more than fifty countries. The company sells its products through its own direct sales organizations, through independent brokers and agents, and to distributors to retailers and commercial users. The company has operations in North America, Africa, Latin America, Europe, Asia Pacific, and the Middle East. About 56 percent of Heinz's sales are from overseas, and the company estimates that 18 percent of sales are from emerging markets; these markets, including China and Russia, are growing rapidly. As part of the international expansion strategy, in 2010 the company completed the acquisition of Foodstar, a maker of soy sauces and fermented bean curd in China. In early 2011, the company announced the purchase of 80 percent of Brazil's S.A. Industrias Alimenticias, which is expected to double Heinz's overall Latin America sales.

Heinz's laboratories develop the company's recipes, which are then duplicated at one of the seventy-nine company-owned factories or one of several leased factories. Most of the bulk raw products are sourced locally when possible, and are purchased against futures contracts in order to stabilize pricing, while other ingredients are purchased on the spot market.

Financial Highlights, Fiscal Year 2010 (ended April 27, 2011).

Heinz reported low single-digit sales gains all through the 200809 recession, and kept the trend going in FY2010 with a strong exit to that year. In an investor conference, Chairman William R. Johnson noted the company delivered its twenty-sixth consecutive quarter of organic sales growth, with that growth in the 2 percent range. Interestingly, the organic growth of the top fifteen brands came in at 4 percent, a departure from what one would expect in such a business. The organic sales gains were especially notable in China, India, Indonesia, and Russia, with gains of 14 percent in those countries. The company earned $3.10 per share for the year, and raised the dividend for the eighth consecutive year.

Reasons to Buy.

The resilience of Heinz's strong brands was apparent during the recession as the company maintained growth in sales and earnings over each of the past three years, and it appears that those brands are continuing to perform well, especially in emerging markets. The company looks to be a solid and steady play in a steady industry with a growth "kicker" in the form of its international business and international expansion. Heinz has been successful recently with its new brand introductions, leveraging its Global Innovation and Quality Center. Part of the company's product development goal is to derive 15 percent of revenues from products introduced within the previous thirty-six months.

For investors looking for steady and solid shareholder returns, both current and future, Heinz is an attractive choice.

Reasons for Caution.

Growth in emerging markets will come at a cost. Many of the brands we take for granted will require large investments in marketing to establish presence and familiarity. Heinz can also expect to see higher acquisition costs for established local brands as compet.i.tors move into this arena, and international acquisitions in particular can be tricky. Finally, higher commodity prices will produce some headwinds, especially in the near term.

AGGRESSIVE GROWTH.

Hewlett Packard.

Ticker symbol: HPQ (NYSE) S&P rating: A Value Line financial strength rating: A++ Current yield: 0.7%.

Company Profile.

Hewlett-Packard is a global technology solutions provider to consumers, businesses, and inst.i.tutions. The company's offerings span IT infrastructure, services, business and home computing, and imaging and printing.

The company is organized around six reporting segments: Personal Systems Group (32 percent of revenue, 16 percent of profits) is the world's leading provider of personal computers based on unit volume s.h.i.+pped and annual revenue. PSG provides commercial PCs, consumer PCs, workstations, handheld computing devices, calculators and other related accessories, plus software and services for the commercial and consumer markets.

Imaging and Printing Group (21 percent of revenue, 27 percent of profits) is the leading imaging and printing systems provider in the world for consumer and commercial printer hardware, printing supplies, printing media, and scanning devices. IPG is also focused on imaging solutions in the commercial markets, including managed print services solutions, commercial printing, industrial applications, outdoor signage, and the graphic arts business.

Enterprise Storage and Servers (17 percent of revenues, 20 percent of profits) provides solutions for both the enterprise and the small business markets. ESS provides products in a number of categories, including entry-level and mid-range servers, and business-critical systems such as the fault-tolerant Integrity servers.

HP Services (27 percent of revenues, 33 percent of profits) is HP's consulting arm, providing multi-vendor IT services, technology services, consulting and integration and outsourcing services. HPS also offers industry-specific services for communications, media and entertainment, manufacturing and distribution, financial services, health and life sciences, and the public sector, including government services. HPS collaborates with the HP business units as well as with third-party system integrators and software and networking companies to bring solutions to HP customers. EDS, the large integrator and consulting concern that the company acquired in 2008, makes up most of this segment.

HP Software (2 percent of revenues, 5 percent of profits) is a provider of enterprise and service provider software and services, including IT management software, business reporting solutions, and integrated voice/data development platforms. Despite the small percentage of the HP total business, HP Software is a big player, especially in enterprise IT and network management software.

HP Financial Services (1 percent of revenues, 2 percent of profits) offers leasing, financing, utility programs, and a.s.set recovery services, as well as financial a.s.set management services for large global and enterprise customers.

The company has experienced unusual levels of change and upheaval recently. CEO Mark Hurd departed unexpectedly and under somewhat mysterious circ.u.mstances in August 2010; his replacement, Leo Apotheker, started that November and has only weighed in slightly on his plans. Some internal restructuring and a greater orientation to software and services and a wholehearted effort to be part of the "cloud" computing model is in the plans. Notably, Mr. Apotheker, a former CEO of SAP Inc., comes from the software world. The company also reshuffled its board of directors recently; it remains to be seen what the outcome of that move might bring. Finally, the company went on an acquisition spree in 2010, acquiring Palm Inc., networker 3Com, storage technology role player 3PAR, and a few other niche acquisitions to fill holes in its product line and become a bigger player in corporate security and cloud infrastructure. It remains to be seen what these acquisitions will mean to the overall business.

Financial Highlights, Fiscal Year 2010.

Despite the executive suite and acquisition dramas, HP delivered solid results in 2010. Bolstered by a recovery in the economy and particularly in corporate IT spending, HP reported earnings of $3.69 per share, a 14 percent gain from $3.48, on revenues just exceeding $126 billion, a 10 percent increase over FY2009. These numbers reflect recovery and acquisitions but also signal that the company is still growing well for a company of its size. Projections call for continued revenue growth in the 46 percent range with earnings growth to about $4.35 per share, diluted. Cash flow is still huge at nearly $13 billion a year and one of the strengths of the company. The company has also retired almost 900 million shares since issuing about 1 billion shares to complete the 2002 Compaq acquisitionnice to finally pay in full for this purchase, which accounts for some $4050 billion in annual sales (international sales make up about 65 percent of the total).

Reasons to Buy.

We will admit to being frustrated with our call on HP. The company continues to make the 100 Best list despite some obvious missteps. As a pure value play, the fundamentals are there. The price-to-earnings ratio has hovered somewhere near 10 and has been below 10 at times as the company wrestles with CEO and boardroom shenanigansa multiple unheard of in this industry. Cash flow is enormous, and the company occupies a number one position in many of its key markets. HP still has a pure cash cow in the printing business, and has learned to make money (albeit still not that much) in the PC business. CEO Mark Hurd brought tremendous operational efficiencies, cost reductions, and focus, bringing a leaner and meaner company with a resurgent brand. All of that has been put into question with his departure, although most in the business see little true impact on the strong HP brand. Bottom line: With some management stability, a real return from the "cloud" strategy, and with a good showing for recent acquisitions, as well as moderate base business growth expectations, the stock may be positioned for solid advances. But ...