Heinz Retained at Neutral

We maintain a Neutral recommendation on H. J. Heinz Company ( HNZ - Analyst Report ) following our evaluation of the company’s fourth quarter and fiscal 2012 results.

Heinz’s fourth quarter 2012 adjusted earnings came in at 81 cents per share, beating the Zacks Consensus Estimate by 2.5%. Earnings also surpassed the prior-year earnings by 17.4% driven by top-line growth. The top line was up 5.6% to $3.05 billion, once again led by strong growth demonstrated by the emerging markets, ketchup and sauces as well as the top 15 brands.

Fiscal 2012 earnings of $3.35 per share increased 9.5% over the prior year, driven by top-line growth. Earnings also beat the Zacks Consensus Estimate of $3.33. Net sales of $11.6 billion in the year were up 8.8% from 2011 levels. Revenue, however, slightly missed the Zacks Consensus Estimate of $11.67 billion.

We are encouraged by the company’s strong portfolio of brands, especially its top 15 brands, which make up more than 70% of sales and continue to drive growth. The top 15 brands recorded 5.0% organic sales growth in fiscal 2012. The company is also increasing its marketing spend to push up the performance of these brands.

Heinz’s popular brands include Heinz Ketchup, Weight Watchers Smart Ones frozen dinners, Classico sauces, Jack Daniels barbeque sauces, Quero tomato-based sauces and ketchup, TGI Friday's single serve meals and many more. The company’s largest and fastest growing product category is ketchup and sauces led by the iconic #1 ketchup brand, Heinz. Global ketchup sales grew 8% organically in fiscal 2012. We believe the company is well positioned to capture the growing demand for this $110 billion global category given its strong brand, market position and global scale.

The company has a significant presence outside U.S. which now generates more than two-thirds of the company’s sales versus less than 50% 10 years ago. The company has delivered positive growth in Europe despite the challenging conditions. Most importantly, Heinz is generating solid growth in the emerging markets of India, China and Indonesia. All these markets are showing good growth in all Heinz products, especially ketchup, sauces and infant nutrition goods due to brisk demand. Management estimates that almost a quarter of the ketchup and sauces business is now in the emerging markets led by ABC, Master and Heinz Ketchup. The company’s heavy investments in the emerging markets are thus paying rich dividends as the largest top-line growth driver.

In fiscal 2012, Heinz invested in productivity initiatives by increasing manufacturing efficiency, reducing overcapacity and streamlining its operations. In addition, the company is also investing in Project Keystone, a multi-year program aimed at increasing Heinz’s competitiveness by adding capabilities, improving processes and systems through SAP. Cost-saving endeavors like these would help counter the impact of rising commodity costs and lay the foundation for long-term growth.

However, continued sluggishness in its largest segment, the North American consumer business, is a significant concern. Heinz’s North American consumer products business, which generates about 70% of the sales in North America, has performed poorly in the past few quarters. The segment has been witnessing consistent volume declines mainly due to the dull economic environment and poor performance of the Ore-Ida frozen brand. Though management’s effort to turn around this business is encouraging, we prefer to stay on the sidelines until the company shows some real success.