H.J. Heinz Company (NYSE:HNZ) had a challenging second quarter facing pressure on both top-lines and bottom-lines. With 80% of its revenues coming from developed markets that have seen a weak recovery, its revenues increased barely 1%, with 3% decline in sales volume, with particularly dismal results from Australia and ongoing weak traffic trends in U.S. Foodservice. Compounding the headwinds, gross margin for the quarter worsened by 180 bps, weighed down by commodity inflation, which outpaced pricing and productivity gains. Heinz manufactures and markets an extensive line of processed food products that includes condiments, meals, snacks and infant/nutrition products and 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).
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As consumers stayed cost-cautious about grocery expenditures amid weak economic recovery in the developed markets, Heinz’s global sales volume declined by 3%. To compete better with lower-priced private label products, Heinz swiftly introduced smaller packaging and product sizes across its portfolio to reduce the entry-price of its products, targeting the low-income consumer segment spending less that $50/week on groceries. It nonetheless charged 3-4% more per unit volume in response to significantly higher input costs.
The major downside to Heinz’s sales came from Asia-Pacific, particularly Australia and U.S. Foodservice. The two contribute to 10% and 12% of Heinz’s sales respectively. Both these segments suffered a volume decline in excess of 5%. While the Australian market suffered owing Coles-Woolworths retailer price war, U.S. Foodservice suffered declines waiting to see any pick up in restaurant traffic. Yet, emerging markets provided some respite, delivering 16% organic sales growth, led by China, India, Latin America and Indonesia.
Expecting Higher Inflation For Fiscal 2012
Gross margin for the quarter worsened by 180 bps, weighed down by commodity inflation, which outpaced pricing and productivity gains. More than half of the operating income decline came from dismal performance in Australia and U.S. Foodservice, which contributed 30% and 25% to the decline respectively.
Commodity inflation touched a high of 10% for Heinz this quarter, representing more than 400 bps of margin in Q2. Even if the commodity prices soften for Heinz over the second half of the fiscal year, full year market inflation is still expected to reach 7.5%, that is 50 bps higher than the company’s projections while entering the year.
We have a revised $54.50 Trefis price estimate for H.J. Heinz Company, which is around 8% ahead of the market price.