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  1. Analysis
August 24, 2011

On the money: Heinz battles to adapt to “difficult” Australian market

HJ Heinz is taking action to revitalise its operations Australia, where its business put in a "poor performance" in the first quarter of its financial year, CFO Art Winkleblack has said.

By Dean Best

HJ Heinz is taking action to revitalise its operations in Australia, where its business put in a “poor performance” in the first quarter of its financial year, CFO Art Winkleblack has said.

The company saw its sales in Australia, a market that generates just under US$1bn in annual revenues, fall 8% on a constant-currency basis in the three months to 27 July. Problems in Australia also hit Heinz’s gross margins in the wider Asia-Pacific region, which fell by 2.1% and where operating income before the benefits of foreign exchange was down 20%.

Speaking to analysts after Heinz issued its first-quarter results, Winkleblack hinted at the power of Australia’s two major food retailers Woolworths Ltd and Coles, which account for 80% of grocery sales in the country.

“This is, as many of our peers have talked about, it is a very difficult environment. The reality is, with two key customers, there has become, as I mentioned, an inhospitable environment for grocery manufacturers,” Winkleblack said. “We’ve seen our margins squeezed as the pressure comes on.”

In May, Heinz announced plans to close one plant in Australia as part of plans to restructure its supply chain and manufacturing network around the world. Winkleblack said Heinz had taken “some very aggressive actions” in terms of the structure of its Australian business and had appointed a new managing director of the unit.

“In an environment where the two customers are going to squeeze it that hard, I think being very, very cost competitive is going to be critical. And so that is going to be forcing our hand to do the right things from that angle,” Winkleblack said. “But we’ve got good plans in place. We expect a much stronger back half than first half.”

There was, however, uncertainty on Wall Street about the prospects for improvement in Australia. Sanford Bernstein analyst Alexia Howard said a “retailer war” in the country was “hurting price growth” and added: “It is not entirely clear when the situation may get better.”

Elsewhere outside the US, Heinz saw some positives during the first quarter of its financial year. The company’s first-quarter sales were up 14.9%, driven by emerging markets and the acquisitions in the last year of Brazilian condiments firm Quero and Chinese soy sauce maker Foodstar. Emerging markets accounted for 23% of Heinz’s sales in the first quarter, up from 18% a year ago.

Winkleblack also pointed to “strong sales and traffic growth” in Europe. During the quarter, Heinz’s European sales increased 17.5% and were up 4.9% on an organic basis. Volumes rose 2.2%. “These results were led by an outstanding performance in the UK, where the team is selling more products off the shelf at full price,” Winkleblack said.

Heinz’s UK unit was “cutting off unprofitable trade promotions” and “continuing to ramp up innovation”, Winkleblack said. “The UK had a particularly stellar quarter, and clearly a tough market there. That will continue to be a challenge but the guys are doing all the right things. We’re very pleased with the team there and what they’re doing.”

However, Heinz faced questions about consumer sentiment in Europe and the US and the impact that weak confidence was having on its operations in those markets.

Meg Nollen, Heinz’s senior vice president of investor relations and global procurement management officer, said some US consumers were “truly struggling”, with those shoppers judging value through a price point. “It doesn’t matter what the cost per ounce is, what matters is: ‘Can I afford to buy even a small portion of that this week?’,” Nollen said. There was, she added, a “similar story” in Europe.

Winkleblack added: “You’re seeing folks that are living paycheck-to-paycheck, and so it’s less about the price per ounce and more about the entry price point. And so we’re looking hard at that.”

Heinz’s shares fell in the wake of its results. The company posted falling profits and earnings per share due to costs linked to its supply-chain revamp. The company said it expected its second-quarter earnings per share to be flat or slightly above last year and maintained its forecast for full-year EPS to increase by 6-8% when measured at constant exchange rates.

Barclays Capital Andrew Lazar said the consensus forecast among analysts for second-quarter EPS was for growth of 8% but said estimates would “likely come down” after Heinz’s announcement.

Lazar said some investors would also “question whether Heinz is being realistic” in keeping that forecast but said the “top end of this range remains in reach”.

Nevertheless, Lazar said Heinz had implied that earnings would accelerate during the second half of the year, which he said some investors would see as a risk.

“While the high end of guidance is no lay-up in our view, particularly in light of a volatile input cost environment and the potential for more severe volume elasticity as more pricing begins to hit shelves, at the very least management expectations don’t appear to be wildly unrealistic,” Lazar explained. “That said, with F2Q estimates likely coming down across the Street, we suspect investors view a back-half acceleration as increasingly risky, as it likely leaves Heinz with less room for error.”

For more from the Heinz conference call, please visit Seeking Alpha.

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