Heinz’s Thicker Margins And Global Growth Will Lift Results

H.J. Heinz & Co. (NYSE:HNZ) is scheduled to announce its earnings for Q2 of fiscal 2013 on November 20. The consumer foods giant saw a strong start to fiscal 2013 last quarter with strong organic sales growth complemented by a recovery in gross margins in spite of a persistent rise in commodity costs.

The company has managed to deliver consistent organic sales growth over numerous quarters and has circumvented declines from deteriorating developed economies through strong growth in emerging markets, global ketchup and its top 15 brands. We expect this trio of growth engines to drive sales this quarter as well and believe that the company will see a further recovery in gross margins, aided by lower commodity costs. However, this could be offset by foreign currency losses due to a strong dollar.

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Global growth engines continue to thrive

Heinz has identified three primary areas to drive long term growth – emerging markets, Global Ketchup and top 15 brands. This focused approach along with pricing and packaging strategies to adapt to shifting demographic and consumer behavior trends in developed markets, has driven sales growth for the company through the protracted global slowdown.

The company continues to fare well in emerging markets such as Brazil, India, China and Russia. These countries enabled an unprecedented y-o-y growth of 19.3% in emerging markets last quarter, which more than offset dwindling sales in markets such as Europe and the United States. Last quarter, emerging markets constituted around 26% of total sales, compared to just 16% in FY 2011.

We believe that increased investment and marketing expenditure in these markets along with concentrated efforts to build emerging market brands such as Complan (India) and Quero (Brazil) will enable the company to maintain impressive growth rates in these markets going forward.

Margins boosted by productivity initiatives and strategic divestments

A surge in commodity costs last fiscal year was not offset by corresponding price increases due to decreasing volumes in developed markets. This led to a 140 bp decline in gross margins (excluding currency impacts) to 34.8% last fiscal year. These figures recovered to almost 36% last quarter, primarily due to the positive impact of initiatives such as Project Keystone and divestments of low margin and non-strategic businesses such as small soups in Germany and the Boston Market brand in the US.

We expect margins this quarter to see further expansion, boosted by lower commodity costs and the continued benefits of the initiatives described above. The Ketchup division had EBITDA margins of 17.7% in calender year 2011. We expect this to expand going forward, eventually stabilizing at around 18.4%.

We currently have a Trefis price estimate of $57 for Heinz, which is in line with the market price.

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