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Published: October 5, 2009
H.J. Heinz Co. (NYSE: HNZ) dominates in
the ketchup market. There is no second. And Heinz has taken
advantage of its revered ketchup brand over the years to develop
organically and acquire other brands.
However, its overdependence on developed markets and a sluggish
U.S. consumer are currently holding the company back.
Emerging markets are where growth is today. It’s clear that
Heinz understands that, because emerging markets now account for
about 14% of the company’s sales. But the rate of Heinz’s
emerging market sales growth is still disappointing.
Heinz has been growing this category, but only at a rate of
about 1% to 2% of its total sales per year -- even with the
company’s brand acquisitions. And to make matters worse Heinz
was hit with currency losses in its most recent quarter, and
these currency dynamics will likely persist.
Heinz’s emphasis on China, Russia, India, as well as other
emerging markets like Poland and the Middle East is encouraging.
But it is disappointing to see a lack of emphasis on Brazil.
In addition to the challenges
Heinz faces in penetrating new
markets, the company is up against
strong headwinds at home. Heinz’s
vulnerability to upswings in
commodity prices poses a risk to
margins. And while Heinz has been
confident enough in the strength of
its brands to increase prices, more
cash-strapped consumers are
switching to generic brands to
increase savings. The result has
been a -4% drop in volumes. Consumer
habits do not change easily, so this
trend will be difficult to reverse.
Looking forward, the consumers in
the United States and other advanced
economies will remain weak. American
consumers, in particular, continue
to struggle with high levels of
debt, surging unemployment, and
depleted nest eggs. In fact, the
wealth effect of seeing an average
-15% drop in the value of their
homes -- which comprises some 70% of
the equity of a typical U.S.
household -- and the huge drop in
the equity markets -- which
represents another 20% of the wealth
of households -- has prompted
consumers to increase their savings
rate for the first time in decades.
The personal savings rate is near
5%, and it could exceed 8%. This
means that consumption will remain
depressed and consumers will remain
focused on cost savings for the
foreseeable future. Therefore, the
shift at supermarkets to generic
labels will continue.
This trend also will have a negative
impact on Heinz’s food-service
segment, which comprises almost 15%
of its sales. Food-service sales
will suffer disproportionately as
people eat more at home instead of
dining out.
Longer term, as the U.S. and other
advanced economies recover, and
Heinz achieves stronger market
penetrations in fast-growing
markets, I believe it will indeed be
able to produce above-average
returns. But in the meantime, very
strong cashflows from its existing
brands will support Heinz stock and
allow the company to return an
attractive dividend.
And right now, the 4.2% dividend
yield that Heinz’s stock offers is
very appetizing. So long term
holders should keep holding the
stock.
However, the current headwinds for
the company and challenges in the
U.S. market, foreign exchange,
commodity costs and other costs
involved in penetrating new markets
will keep limiting the stock’s
appeal -- even as a defensive play
in down market periods.
The stock’s Price/Earnings to Growth
(PEG) ratio, which is above 2, is a
strong warning sign. It says that
buying at these levels is paying too
high a premium for the Heinz’s
earnings growth rate. That is
symptomatic of the headwinds in
earnings that I mentioned
previously. Thus, it is not
advisable to go into this stock
right now.
I would stick with
defensive stock recommendations,
like Campbell Soup Co. (NYSE: CPB),
The Coca-Cola Co. (NYSE: KO)
and Goldman Sachs Group Inc.
(NYSE: GS), which have
outperformed and are executing
strongly in emerging economies.
-- Horacio Marquez
Contributing Editor
Money Morning |
