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Heinz Remains on Tight Rope

CAG K

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We maintained a Neutral recommendation on H. J. Heinz Company following appraisal of the company’s first quarter fiscal 2013 results.

Heinz’s first quarter 2013 adjusted earnings of 87 cents per share beat the Zacks Consensus by 4.8%. Earnings also exceeded the prior-year earnings by 10.1% largely due to a lower-than-expected tax rate, organic sales growth and productivity improvements. Though reported revenues declined 1.5% to $2.79 billion due to currency headwinds, organic revenues grew 4.8%. The organic revenue growth was driven by volume growth and pricing gains.

The company maintained its organic sales growth guidance to be at least 4%. It continues to expect earnings in the range of $3.52–$3.62 per share, representing a constant currency growth of 5–8% from fiscal 2012 levels.

We are encouraged by the company’s strong brand portfolio, especially its top 15 brands, which account for over 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 boost 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% generated 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. 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. Heinz competes with Kellogg Company (K - Analyst Report) and ConAgra Foods, Inc. (CAG - Analyst Report).

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