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North American meat-centric food company, Hillshire Brands (NYSE:HSH) announced lower first quarter earnings for the fiscal year ending June 2014 (FY14) on thinner margins and muted sales growth. However, sequential improvement in lunchmeat sales was a positive sign as the product line ran into troubles earlier this year on manufacturing issues and failed packaging innovation.

Going forward, we expect margins to remain under pressure during the second quarter on commodity inflation and tough year-on-year comparisons. However, sustained pricing and cost savings from ongoing productivity initiatives could help the company report better margins during the second half of FY14. On the other hand, sales growth in the coming quarters would largely depend upon Hillshire Brands’ performance in the lunchmeat and corn dog categories. [1]

Formerly known as Sara Lee Corporation, Hillshire Brands began trading under the “HSH” symbol on June 29, 2012, following the spin-off of its international coffee and tea business. It sells a variety of packaged meat products that include hot dogs, corn dogs, breakfast sausages, dinner sausages and deli meats, as well as a variety of frozen baked products. These products are sold through the retail channel to supermarkets, warehouse clubs and national chains in North America. The company also sells a variety of meat and bakery products to foodservice customers in North America.

We currently have $34 price estimate for Hillshire Brands, which we will soon update based on the third quarter earnings announcement.

Muted Sales Growth

Hillshire Brands’ first quarter sales grew marginally as growth in foodservice sales was largely offset by continued weakness in the retail division. The company’s retail division, which makes up ~75% of the company’s total sales revenues as well as our price estimate, operates four mainstream brands, namely Jimmy Dean (breakfast sausage), Ball Park (hot dogs), Hillshire Farm (meat and sausages) and State Fair (corn dogs).

The decline in retail sales during the first quarter was primarily due to heightened price-based competition in the corn dogs category and lower lunchmeat sales. While we expect pricing pressures to continue to drag down State Fair corn dog sales in the coming quarters, the sequential improvement in Hillshire Farm sales seen during the quarter was encouraging.

A billion dollar lunchmeat and smoked sausage brand, Hillshire Farm contributes almost 25% to the company’s net sales. During the last few quarters, Hillshrie Farm lunchmeat sales have been under pressure due to packaging quality related issues with the new manufacturing line followed by the failed clear lid innovation. However, the restored manufacturing line and the new red lid seem to be working well for the company in recovering its lost ground in the category. During the first quarter earnings call, the company officials maintained their positive outlook on Hillshire Farm pointing out to the strong growth momentum seen in the brand’s sales during the past four weeks. We therefore expect the company’s second largest brand to show some strength in the coming quarters. [2]

Thinner Margins

Hillshire Brands faced tough margin comparisons during the first quarter in comparison to the year ago period as higher than expected commodity inflation squeezed gross margins this year. The company reported a 320 basis points decline in adjusted gross margins during the quarter. Even though marketing and promotional (MAP) spending came down heavily due to uneven comparisons, adjusted selling, general and administrative costs increased ~2%, which resulted in a 260 basis points contraction in operating margins. [1]

Going forward, we expect margins to remain under pressure as higher feed grain costs due to severe drought conditions last year have led to inflation in beef, pork and poultry prices this year. [3] Moreover, we also expect MAP to increase in the coming quarters as the company continues to work on its strategy of investing behind its brands. Hillshire Brands plans to raise its MAP spending as a percentage of revenues to 5% by 2015, up from the historic average of 3.5%. [4]

Notes:

  1. Hillshire Brands Reports Solid Start To Fiscal 2014, hillshirebrands.com
  2. Q1 2014 Earnings Release and Conference Call, investors.hillshirebrands.com
  3. PPI Detailed Report, bls.gov
  4. The Hillshire Brands Company Discusses Plans For Growth At CAGNY, www.hillshirebrands.com

Disclosure: No positions

Source: Hillshire Brands' Earnings Decline On Thinner Margins But Sales Outlook Improves