H. J. Heinz Company (HNZ) posted better-than-expected first quarter 2013 adjusted earnings of 87 cents per share, beating the Zacks Consensus Estimate of 83 cents by 4.8%. Earnings also exceeded the prior-year earnings by 10.1% due to lower costs.
During the quarter, the company completed the sale of its U.S. Foodservice frozen desserts business. This transaction resulted in a $31.5 million pre-tax loss, which has been recorded in discontinued operations.
Total sales declined 1.5% to $2.79 billion, down 1.5% largely due to currency headwinds of 5.6%. Organically, revenues were up 4.8% while constant currency organic sales climbed up 4.2%, led by strong growth of core drivers, emerging markets and its top 15 brands. Revenues, however, slightly missed the Zacks Consensus Estimate of $2.8 billion.
Volume gains of 2.5% along with solid net pricing of 2.3% in the quarter contributed to the sales growth. Divestitures, primarily exiting the Boston Market license in the U.S. and divesting a soup business in Germany, reduced total sales by 0.6%.
Top-Line Drivers
The emerging markets were the largest growth driver in the quarter, recording organic sales growth of 19.3%, while reported growth was 11.2%. Global Ketchup sales grew 3.7% organically (declined 1.2% on a reported basis), driven by strong performance in Brazil, Russia and China.
The company’s top 15 brands recorded 5.9% organic sales growth (growth of 0.1% on reported basis), driven by strong sales of brands like Quero, Master, Golden Circle, ABC, Weight Watchers Smart Ones, Heinz and Ore-Ida.
Segment Details
Sales in Europe slipped 7.2% to $778 million in the reported quarter mainly due to an unfavorable impact of foreign exchange. Organically, revenues were up 2.0% (8.0% on a constant currency basis) despite a difficult economic environment. Pricing registered an increase of 2.9% mainly boosted by U.K., Benelux and Eastern Europe. Volume declined 0.9% due to weak economic conditions and soft sales in Continental Europe and Italy. The segment witnessed a 7.8% increase in operating income to $148.2 million on a constant currency basis.
Sales in the North American Consumer Products segment, which sells products to grocery channels in the US, declined 2.0% during the quarter to $759 million. Organically, sales were up 0.9% due to a pricing benefit of 1.0%. Volume remained flat as U.S. retail business’ 1.2% organic growth was offset by a decline in Canada.
The divestiture of the Boston Market license negatively impacted sales by 1.8%. Unfavorable Canadian exchange translation rates decreased sales b y1.1%. The segment witnessed a 2.9% increase (up 2.9% on a constant currency basis) in operating income to $185.3 million on a constant currency basis.
Sales in Asia Pacific slipped 1.9% to $658 million in the reported quarter mainly due to unfavorable foreign currency translation. Organically, revenue was up 4.1% with both pricing and volume registering increases of 1.4% and 2.7%, respectively.
Volumes were up due to strong performances in Indonesia, India, China and Japan, which partially offset the weakness of Long Fong frozen products in China. The segment’s operating income increased 29.5% (30.0% on a constant currency basis) to $79.3 million due to strength in the emerging markets.
Sales in the US Foodservice segment, which manufactures and sells some branded and customized products to food outlets and distributors across US, increased 2.4% to $315 million in the reported quarter. Organic revenue was also up 2.4%. Pricing increased 2.6% and volume remained flat. The segment’s operating income reported a 12.7% increase to $37 million driven by higher sales and cost management.
Sales in the Rest of World segment increased 16.5% to $281 million in the quarter in spite of unfavorable foreign exchange translation. Organically, revenues were up 31.7%, driven by a significant volume growth of 24.9%. Volume was primarily driven by growth in Brazil. Pricing increased 6.8%. The segment’s operating income was up 3.0% (up 3.0% on a constant currency basis) to $33.3 million.
Margin Details
Excluding productivity charges, Heinz’s gross profit declined 1.3% to $1.0 billion, reflecting a $55 million unfavorable impact from foreign exchange. Gross margin, however, went up 10 basis points to 35.9% in the reported quarter, owing to higher pricing and productivity.
Adjusted operating income went up 5.1% on a constant currency basis to 431.9 million driven by gross margin gains. Marketing expense went up 4.5% to $123.4 million as the company invests to boost sales of its leading brands.
Outlook
The company maintained its organic sales growth guidance to be at least 4%. It maintained its constant currency adjusted earnings per share expectation to increase 5–8% over fiscal 2012 levels. However, the company lowered its free cash flow expectation to $1.0 billion from previously-expected level of $1.1 billion.
Our Recommendation
We currently have a Neutral recommendation on Heinz. The stock carries a Zacks #3 Rank (a short-term Hold rating).
We are encouraged by the company’s robust portfolio of brands, especially its top 15 brands, which account for over 70% of sales and continue to drive growth. Moreover, we believe the upside potential in emerging markets, strong marketing investments and ongoing cost saving efforts will boost long-term growth.
However, continued sluggishness in the North American consumer business, its largest segment, is a significant concern. Though management’s effort to turn around this business is encouraging, we prefer to stay on the sidelines until the company’s efforts shows successful results.
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