I tend to believe that Wall Street overvalues the supposed stability of packaged/branded food and beverage companies, which is why investors seldom have the chance to buy the stocks of Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP) or Kellogg (NYSE:K) at really compelling valuations. Within the broader group of expensive food names, I can see an argument for owning Heinz (NYSE:HNZ) today. Not only is Heinz doing relatively well from an organic growth standpoint, but the combination of strong brands in developed markets and a very good presence in emerging markets is compelling to me.
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Fiscal Second Quarter Performance on Target
Heinz Q2 results came in as expected at the sales and margin lines this quarter. While some analysts are likely to make something of the company's weak organic growth in developed markets, a quick look around the comparables suggests that even "meh" results are nothing out of the ordinary today.
Revenue fell a bit as reported, while organic revenue rose a little more than 3% this quarter. Volume contributed to about 40% of the growth, with price action kicking in the rest. North America Consumer revenue was basically flat as reported, but would have been up about 4% excluding the TGIF business. U.S. Foodservice was down a bit, while Europe was down more than 4% (flat organically) and Asia-Pacific rose more than 2%.
Heinz did as expected on margins. Gross margin improved about a half-point, while operating income fell almost 1%. While operating income would have been up a bit in constant currency terms, profits in the North America Consumer business weren't scintillating.
Great Emerging Market Growth Is not a Bad Thing
In reading some of the analyst reports on Heinz's quarter, you would almost think that the company's strong emerging market performance is somehow shameful. Emerging market revenue was up about 13% this quarter, with good results in Brazil and China and double-digit growth in Russia. It's also worth noting that emerging market revenue is very nearly one-quarter of the total, making Heinz one of the most heavily-weighted U.S. food companies to emerging markets.
I fail to see how or why this is a bad thing. Yes, Heinz's developed market growth was sub-1% this quarter, but that's not exactly out of step with what we've seen from companies such as Campbell Soup (NYSE:CPB), Smucker (NYSE:SJM) or General Mills (NYSE:GIS). What's more, it's only going to get harder for companies such as ConAgra (NYSE:CAG) and General Mills to break into emerging markets and take on local players as well as earlier arrivals such as Heinz and Unilever (NYSE:UL). Considering that population and disposable income growth is likely to be higher in these emerging markets in the coming decade(s), I find this strong sales growth to be an encouraging sign.
Is the Marketing Landscape Changing?
Heinz is seeing decent volume growth, and better overall organic growth than many other food companies (for example, Campbell Soup, Smucker, and Kellogg). Nevertheless, management is looking to shift some of its promotional dollars away from traditional ad spending and towards discounts and allowances.
We've heard much the same from Campbell Soup and Smucker recently, so Heinz is hardly unusual in this regard. I suspect some of this may be motivated by a desire to stimulate volume through price, without actually cutting prices.
The Bottom Line
I like the fact that Heinz continues to invest in opportunities such as condiments and sauces in Brazil and China and baby food in Mexico. While I find the company's decision to shift its promotional spending towards discounts and allowances to be curious, we'll soon see how this plays out.
The stock of Heinz is still not cheap; a mid-single digit free cash flow growth assumption points to a fair value more or less in line with the price today. While Heinz may not be bargain-priced, it offers a good dividend and good emerging market growth potential, and aside from perhaps Kellogg I think Heinz would probably be my choice of an admittedly uninspiring (from a valuation perspective) sector.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.