Hillshire Brands (NYSE:HSH) is set to announce its first quarter earnings for fiscal year 2014 on October 31. We expect the company’s top line growth to remain subdued on pricing pressures amid heightened competition in some categories. We will be closely watching for an update on the performance of its lunchmeat and smoked sausages brand, Hillshire Farm, which ran into several issues in the last fiscal year. We also expect Hillshire Brands’ operating margins to face tough year-on-year comparison on higher commodity and marketing costs during the quarter.
Formerly known as Sara Lee Corporation, Hillshire Brands began trading under the “HSH” symbol on June 29, 2012, following the spin-off of its international coffee and tea business. It sells a variety of packaged meat products that include hot dogs, corn dogs, breakfast sausages, dinner sausages and deli meats, as well as a variety of frozen baked products. These products are sold through the retail channel to supermarkets, warehouse clubs and national chains in North America. The company also sells a variety of meat and bakery products to foodservice customers in North America.
Our $34 price estimate for Hillshire Brands is almost in line with the company’s current market price.
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Subdued Revenue Growth
Hillshire Brands’ retail division makes up ~75% of its total sales revenues as well as our price estimate for the company. The division operates four mainstream brands, namely Jimmy Dean (breakfast sausage), Ball Park (hot dogs), Hillshire Farm (meat and sausages) and State Fair (corn dogs) that occupy leading market share positions in their respective product categories. 
The company follows a growth strategy of creating iconic brands through innovative products, backed by strong marketing in order to reduce the price elasticity of demand. The biggest benefit of this strategy lies in increased pricing power with the companies that enable them to sustain profitability without sacrificing too much on volume growth.
This strategy has worked well for Hillshire Brands’ Jimmy Dean and Ball Park brands, which posted strong 7.3% and 5% volume gains y-o-y respectively, during the last fiscal year (FY13). However, it did not work as well for the other two mainstream brands of the company. Increased price-based competition in the corn dogs category prompted Hillshire Brands to ramp up promotional spending behind State Fair. ((State Fair Brand Gives Consumers Nationwide A Golden Opportunity To Win Big With Its “Find The Golden Stick” Promotion, hillshirebrands.com)) However, despite higher promotional spending the brands’ consumption volume decline 2.4% last fiscal year. We expect pricing pressures amid heightened competition to weigh on State Fair’s sales during the first quarter as well. 
On the other hand, Hillshire Farm faced several issues last year. The first was the packaging quality related issue with the new manufacturing line of its lunchmeat products. Then, the company’s clear lid innovation on the same line of products failed to attract consumers. It should be noted that Hillshire Brands hailed this change as a big innovation in meat packaging. Meanwhile, competitors quickly took the opportunity to gain market share. As a result, despite strong performance during the first half of last fiscal year, Hillshire Farm’s consumption volume declined ~2% for the full year. 
Being a billion dollar brand, Hillshire Farm contributes almost 25% to the company’s net sales. Therefore, it had a significant impact on its overall performance. During the fourth quarter earnings call, the company executives mentioned that manufacturing lines were running smoothly now and that they had replaced the transparent lid with a red one, which is getting a positive response from consumers. However, we will be closely watching for an update on the impact of these changes on Hillshire Farm’s sales during the first quarter, both sequentially and y-o-y. 
Tough Margin Comparisons
Profit gains helped Hillshire Brands drive earnings growth last fiscal year despite flat revenues. Gross margins adjusted for dispositions and the impact of other significant items expanded by almost 150 basis points on relatively lower commodity inflation. As a result, company-wide operating margins expanded by 100 basis points to 9.3% despite higher marketing and promotional expenses, which increased by ~30% y-o-y. 
However, we expect Hillshire Brands to report thinner operating margins during the first quarter on higher marketing and promotional expenditure and tough comparisons due to last year’s deflationary commodity costs. It should be noted that lower commodity prices resulted in favorable input costs during the first half of the last fiscal year. However, higher feed grain costs due to severe drought conditions last year have led to inflation in beef, pork and poultry prices this year, which will lead to tough year-on-year comparisons.  Moreover, increased marketing and promotional spending by the company to regain its lost ground in the lunchmeat and corn dog categories will add further pressure on operating margins. Notes:
- Hillshire Brands SEC Filings, sec.gov [↩] [↩]
- Q4 2013 Hillshire Brands Co Earnings Conference Call, investors.hillshirebrands.com [↩] [↩]
- Hillshire Brands Management Discusses Q4 2013 Results – Earnings Call Transcript, seekingalpha.com [↩] [↩]
- PPI Detailed Report, bls.gov [↩]