Emerging Markets Tip the Scale at Heinz

| About: The Kraft (KHC)
Food companies love scale. It gives them the power to negotiate cheaper costs and the ability to negotiate placement and shelf space at retailers. In the past, food companies, overly reliant on developed markets, relied on new products to drive such scale. Today, it comes not only from new products, but also from expansion into emerging markets. These new markets are fast becoming critical growth centers for food companies such as Heinz (HNZ).
Heinz has been selling its products in places like China since the 1980s. But, only recently has the scale reached meaningful levels. Last quarter, organic sales in emerging markets increased 12%. Double digit growth, while common in tech-land, isn't typically associated with major food makers. Yet, emerging market strength offset domestic headwinds to help total revenue increase 6% to its highest level ever. And, since these fast-growing markets are still young, margins benefit as volume increases, which helped earnings grow 15%.
How much scale does Heinz have overseas? Last year, emerging markets accounted for 17% of Heinz sales, and this year they're expected to represent 20%. Going forward, the outlook is even stronger. Heinz expects emerging markets may make up as much as 30% of its revenue in the next five years, with sales increasing from $1.7 billion to $5 billion by 2016.
To accelerate emerging market sales, Heinz bought Quero, a Brazilian condiment maker, this year and Foodstar, a Chinese soy sauce and bean curd maker, last year. In Quero, Heinz got $325 million in sales, which doubled its Latin America revenue. Quero also gave Heinz popular brands with channel penetration. In acquiring Foodstar, Heinz expanded its reach in China beyond infant cereal and frozen dim sum. In both instances, expect Heinz to leverage retail relationships and its product portfolio for sales upside.
Additionally, Heinz is finding itself able to re-engineer its overseas product portfolio to expand domestic sales too. As developed nations become increasingly diverse, tastes are shifting. This presents opportunities for Heinz to take overseas brands and reposition them in the U.S., Canada and Europe. In the U.S. alone, the Hispanic population provides Heinz just that kind of growth opportunity.
While input costs have been rising, Heinz has been restructuring for margin growth. Gross margins were up 80 basis points last year and full year operating cash flow hit a record $1.26 billion. Long term Heinz expects supply chain initiatives, which include consolidating factories and headcount, to boost earnings to 9% annually, up from its prior 6% long range target. Over the next five years, Heinz expects 40-60 basis points of annual margin growth. Not bad given the commodity cost headwinds.
Emerging markets success and early returns from cost cutting are behind Heinz 7%-8% revenue and 6%-8% earnings growth guidance for this year. The boost in cash flow supports dividend growth. In June, Heinz upped its dividend $0.12 to $1.90. Since 2004, the dividend has increased some 80% and at current prices, the stock yields 3.8%. This is pretty compelling given current bond yields.
In Heinz, investors get an emerging markets growth story, accelerating earnings and dividend growth alongside the predictable revenue associated with food companies. With markets pulling back, Heinz is positioned to provide shareholders upside.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HNZ over the next 72 hours.