Heinz Still "America's Favorite Ketchup"

Last Updated Oct 1, 2009 8:35 PM EDT

Not withstanding the global economic slowdown, H.J. Heinz got its fiscal 2010 new year off to a good start, reporting sales gains of 4.5 percent (adjusted for foreign currency changes), according to its quarterly filing. Net pricing increases of six percent, however, offset volume declines of 4.3 percent. Can the food company, known for Heinz ketchup, Ore-Ida frozen potato label, and other name brands, continue to pass along its commodity costs without driving financially pressed consumers away to cheaper store brands?

From the company's factory kitchens to the grocery store, the company uses a variety of raw foods (such as tomatoes and potatoes), sweeteners (including cane sugar and high fructose corn syrup), and containers (made of glass, metal, plastic, paper, or fiberboard) - not to mention the fuel needed to produce and transport the company's products. Commodity inflation pressured pricing and productivity improvements for the quarter-ended July 29, with gross profit margin falling 80 basis points to 35.4 percent.
And ingredient costs are rising, as talk of a global economic recovery reignites speculative interest in many markets. The Commodity Research Bueau (CRB) Foodstuff Spot index, a basket of 10 goods (including corn, sugar, and wheat), suggests food inflation is coming. After hitting a two-year low in early July, the index has rallied almost 3.5 percent to 305.13 at September 25.

Although the company has been disciplined in managing costs (principally through productivity gains on deals and allowances and factory closings), the fact is that commodity price inflation is passed on through retail price hikes to consumers. Net pricing increased sales by 3.3 percent in fiscal 2008 and 2.1 percent in fiscal 2007, according to the fiscal 2008 annual filing.

The company has traditionally resisted cutting prices of its name brands, preferring to maintain customer loyalty through increased ad dollars and by leveraging its size and category leadership positions.. For example, the Heinz brand generates almost $4 billion in annual sales, with a global reach across all of the company's food categories-ketchup in the United States, salas cream and baked beans in Great Britian, and baby food in Canada and Latin America - and its products enjoy #1 or #2 market share in more than 50 countries.

Remarkedly, even with the highest unemployment rate in 27 years, the company continues to maintain its pricing power in the United States. Chief financial officer Art Winkleblack told analysts on the earnings call that 88 percent of total U.S. retail sales were sold off the shelf at full price. That said, fears about consumers buying more store brands or trading down to discounters are mostly overblown, in my opinion.

The company is also driving demand across the globe with constant product innovation. A few examples cited by Winkleblack on the call: Plasmon premium vegetables and a stand-up receivable pouch for infants in Italy; a reduced salt-and-sugar variety of its Heinz's Snap & Pop Beanz in England; and, new infant cereals in Russia and Latin America.

Despite energy and food cost headwinds - and an uncertain economic recovery - the company will continue to avoid unprofitable promotions, said Winkleblack. No doubt, mealtime will continue to be "an uncommonly good experience" for millions of loyal consumers of around the world.

The company maintained its forecast for fiscal 2010 sales growth of 4 percent to 6 percent, which puts revenue in a range of $10.5 billion to $10.7 billion.
  • David Phillips

    David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

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