H.J. Heinz (NYSE:HNZ) will soon release its Q2 results. While we expect continued robust top-line growth from emerging markets, gross margins may suffer due to higher input costs despite pricing and cost-cutting efforts. We will look for updates on Heinz’s performance in Australia where Coles-Woolworths supermarkets price war has created an inhospitable environment for branded products like Heinz that are struggling against lower-priced private label goods. Heinz manufactures and markets an extensive line of processed food products that includes ketchup, condiments and sauces, meals and snacks and infant/nutrition products. The company competes with major food and consumer companies like Kraft Foods (NYSE:KFT), Tyson Foods (NYSE:TSN), ConAgra Foods (NYSE:CAG) and Campbell Soup Company (NYSE:CPB).
High growth in emerging markets: 5 of the top 15 are now emerging market brands
Emerging markets are the primary growth engines for Heinz’s top line and will contribute to 20% sales by 2011 compared to just 9% in 2005. Heinz aims to generate 25% of its revenues from emerging markets by 2016. (Read Heinz Heads to $62 on Growth from Emerging Markets). The company has a diversified footprint across majority of key emerging markets and has been benefiting from double-digit growth in China, India, Indonesia and Russia. The company also recently made two major acquisitions, Foodstar in China and Quero in Brazil, both of which delivered strong growth in their respective markets last quarter and are now among the firm’s top 15 global brands. We expect to see continued strong growth from these emerging markets this quarter as well.
Higher pricing to offset input inflation
Heinz has been suffering significant input inflation this year exceeding 7% that will drag on gross margins. This prompted higher pricing of Heinz products over the last few months. Heinz nonetheless introduced smaller packaging to reduce the entry price for its packaged food products for budget shoppers. Apart from pricing, the downward pressure on gross margins will also get some upside from the ongoing productivity initiatives that are expected to improve gross margins annually by 40-60 basis points.
The Coles-Woolworths War Down Under: Heinz Suffers
As price-war continues between Australia’s two biggest retailers Coles and Woolworths, that account for >87% store market over 2000 sq-mts, both have been increasingly stripping branded products off their shelves, replacing by lower-priced home-brands and private label products that provide them with higher margin mix. Struggling to compete with lower-priced private-label products, Heinz is left with almost no room for pricing and has been performing poorly with both sales and gross margins coming down. With no positive news on the front, we expect the gloomy performance in Australia to continue. (Read – Heinz, Branded Products Suffer Down Under as Retailers Woolworths & Coles Battle)
We have a $60 Trefis price estimate for H.J. Heinz Company, which is around 10% ahead of the market price.