Kraft Heinz Co. last week gave some indication of the financial performance of its constituent parts when the newly-formed company published second-quarter numbers for the former Kraft Foods and HJ Heinz, the last periods as independent entities before the merger closed in July. Lacklustre sales trends remain but the group is also positioned to meet its long-term margin potential and could emerge a beneficiary of potential sector consolidation. Katy Askew reports.
Kraft Heinz Co. officially came into existence last month, following the merger of Kraft Foods Group and ketchup giant HJ Heinz. In March, when the merger was first announced, management insisted the tie-up was about more than cost cutting (with savings expected to total US$1.5bn on an annualised basis by 2017). The deal, it was insisted, is also about growth. In particular, Kraft's well-known grocery brands could be fed into Heinz's international distribution channels, the company suggested.
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However, last week, it became clear exactly how challenging delivering on this growth mandate is likely to be. The Oscar Mayer-to-Wattie's group issued second-quarter results for Kraft and Heinz for the periods to 27 June and 28 June respectively. On the Kraft side, sales were down 4.9% to $4.52bn in the second quarter – missing consensus expectations for revenue of $4.69bn. Organic sales – stripping out foreign exchange – were down 3.3%, consisting of a 2.6 point decline from volume/mix and a 0.7 point fall from lower net pricing.
Speaking during a conference call, Paulo Basilio, the Kraft Heinz CFO, said the company's volume mix was hit by the timing of Easter, inventory shifts at customers and lower ready-to-drink sales due to lower promotional activity. "Lower net pricing reflected pricing actions in the cheese and foodservice businesses related to lower dairy costs. These were partially offset by the carry-over impact of price increases taken in prior quarters."
Heinz also reported lower second-quarter sales – with revenue dipping 4.1%, primarily due to a negative 9.4 point impact from foreign exchange translation. Organic sales at the condiments maker were up 5.9%, but gains were underpinned by higher pricing. Volumes increased just 1.7%
Fiona Cincotta, a market analyst at Finspreads.com, said the results "disappointed". The sales declines, Cincotta suggested, can be attributed to changing consumer preferences and an increasing global appetite for healthier, less processed foods. "Changing tastes of consumers towards less processed healthier foods means the environment and the outlook remains challenging for Kraft Heinz," she suggested.
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By GlobalDataCincotta also stressed the significant challenge Kraft Heinz faces as it works to integrate the two businesses. "Merging these two companies to form the world´s fifth-largest food company, in a $50bn deal, was always going to be a mammoth task and these results show that there really is still a very long way to go before the two businesses are integrated and synergies maximised," she told just-food.
Nevertheless, Kraft Heinz's earnings performance does point to the potential to boost margins. In the second quarter, higher earnings were booked at both the Kraft and Heinz sides of the business.
At Kraft, operating income was $923m, and diluted EPS was $0.92, inclusive of one-off factors in the quarter. "Excluding the impact of these factors in both years, operating income grew at the mid-single-digit rate and EPS grew at the double-digit rate," Basilio said.
"This growth was primarily driven by a combination of favourable commodity costs net of pricing, mainly in the dairy and meat categories; lower SG&A expenses, driven by a reduction in advertising spending; and lower manufacturing costs driven by net productivity."
Earnings were also up at Heinz. Adjusted EBITDA rose 6.7%, to $739m. Basilio attributed the growth to an increase in gross profit thanks to increased sales in North America and Venezuela, "cost of goods sold productivity initiatives", and "an overall reduction in SG&A".
In the two years under the ownership of Warren Buffett's Berkshire Hathaway and 3G Capital, costs had been cut at Heinz to boost margins. In SEC filings released last week, Kraft Heinz revealed 4,050 staff had left the former Heinz business between the end of April 2013 and 28 June this year, when the merged was completed, amid "restructuring and productivity initiatives" undertaken by 3G and the ketchup maker's management.
Last week saw the first confirmed cuts at the new Kraft Heinz. It said it is to axe around 2,500 posts across the US and Canada.
"We have developed a new streamlined structure for our organisation to simplify, strengthen and leverage the company’s scale. This new structure eliminates duplication to enable faster decision-making, increased accountability and accelerated growth," a spokesperson for Kraft Heinz said. "These necessary actions will better position the company for future growth. Furthermore, these efforts position our company to realise substantial synergies that will drive savings to be reinvested in our brands and products."
The aggressive cost-cutting drive at Kraft Heinz is likely to improve earnings growth potential – and we can expect the bottom line's upward trajectory to far outstrip the group's lacklustre top-line outlook.
Sanford Bernstein analyst Alexia Howard suggested these savings mean Kraft Heinz will grow its profits ahead of the other food sector majors – and added the company's returns could be helped as its owners look to make further deals "We believe that Kraft Heinz Co. is likely to achieve superior returns for shareholders over the next several years based on it becoming a platform company that successfully conducts a roll-up of the packaged food industry," she predicted.
Howard characterised the US food sector as "the most fragmented consumer staples sector" in the developed world and suggested Kraft Heinz is well-positioned to capitalise on market consolidation opportunities. In the more immediate term, she continued, margins are likely to expand at the firm. "Although another deal is unlikely to be announced for another 18 – 24 months, in the nearer term we are likely to see a step-up in margins at Kraft, once cost-cutting measures kick-in. At Heinz, this took nine months to bear fruit," she wrote in an investor note.
While the enlarged Kraft Heinz could struggle – like many of its peers – to carve out organic growth, expansion via M&A and a strong focus on margin improvement appear to be on the cards.
