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Five Things You Need to Know: Heinz Plays Pricing Ketchup


The consumer downshift from discretionary spending to staples spending continues to show up in interesting areas.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Producer Price Index Jumps

Producer prices jumped more than forecast in January, the Labor Department said. Inflation statistics from the wholesale level rose 1% while the core, which excludes food and energy, rose 0.4%.

Year-over-year, headline producer prices have risen 7.4%, the most since October 1981, while the core is up 2.3% through January.

Looking inside the numbers, energy prices increase 1.5% in January after December's 0.3% decline. But everyone expected that with crude oil at $100 a barrel. Food prices rose 1.7% while crude food prices, the cost of the raw materials, jumped 2.7%. And this leads us to today's Number 2...

2. Heinz Plays Pricing Ketchup

Speaking of producer prices and increases in raw food materials, the Heinz (HNZ) earnings call this morning opens a window into how food companies are handling increases in raw materials costs.

Overall Heinz reported a decent quarter in the face of rising raw materials costs, but gross margin declined meaningfully, from 37.1% to 35.8%, and the question going forward is can the company continue to pass through higher food costs to customers? The answer for Heinz is mixed.

The company has taken some pricing measures to offset rising costs, but CFO Arthur Winkleblack explained that the company at this point is more concerned about absolute dollar profit growth in terms of gross profit and operating income rather than margins. "We think that the best long term answer for both top line and bottom line growth is to price to almost cover commodities but certainly not go past that," Winkleblack said during the question and answer session.

Heinz also indicated the company is seeing some shift in product mix related to an overall slowdown in casual dining and an increase in eating at home. "We also had a bit of a mix change," Winkleblack said. "We saw strong desserts performance along with that bundled or complete meal solution that I talked about, we saw a strong soup performances as well." But, he added, it's not an easy pricing environment in the food service industry right now given the economy.

The consumer downshift from discretionary spending to staples spending continues to show up in interesting areas, and this leads us to today's Number 3...

3. Speaking of Discretionary vs. Staples

This morning Target (TGT) reported what the company characterized as "disappointing financial results" due to "sharply softer sales" trends in the fourth quarter. Revenues increased 6.4% in the fourth quarter but the company's gross margin rate declined 53 basis points due to faster sales growth in their lower margin consumable and commodity category. In other words, consumers continued to downshift and shun discretionary spending in favor staples-like spending.

Meanwhile, here is what stood out to us from the call. Credit card receivables at the end of the quarter were 29% higher than year-end 2007. That's pretty strong growth. The company said this is partly reflective of a move to offer higher limit Target Visa cards to their higher credit quality customers last summer, but also due to the overall industry-wide trend of a decline in payment rates that began in the third quarter, as well as somewhat higher delinquency metrics.

So, the bottom line is the company has seen a nice spike in credit card receivables while simultaneously seeing a slowdown in consumer discretionary spending? Hard to see how that is particularly "good" news for anyone looking further out than the last quarter.

Target is planning for a margin rate decline in core retail operations for 2008, but companies, specifically retailers, are probably still too optimistic. Many retailers continue to view last quarter as an aberration and are planning for an increase in both traffic and sales in the second half of the year given what they expect to be soft year-over-year comparables. We shall see.

4. Not a Good Picture

The S&P/Case-Shiller home-price index dropped 9.1% year-over-year in December, the most on record and marking a full year of declining home prices. That sounds bad, sure, and may help explain why Consumer Confidence this morning fell to its lowest level since 1993.

Speaking of the early 90s, how does this housing price deflation compare to the 1990-91 housing recession? Not very favorably. Consider that during the 1990-91 housing recession the annual rate of the Case-Shiller U.S. National Home Price Index bottomed at -2.8%.

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Finally, on a related note, RealtyTrac, a company that tracks national foreclosure statistics, reported that home repossessions rose 90% last month compared to January 2007, according to Bloomberg. "The most troubling thing is that we are seeing more and more of these properties actually going all the way through the process and going back to the banks,'' Rick Sharga, executive vice president of Irvine, California-based RealtyTrac, said.

5. In a Deflationary Landscape, Less Really Is More

This morning we ran across an interesting piece in the New York Times Science section, "The Advantages of Closing a Few Doors," on research showing that while we seem to like having more choices, we actually benefit from having fewer options. Deflation of a different sort? Perhaps, but the bottom line is the same: the shift in social mood that creates the right conditions for asset price deflation also creates the right conditions for paring down a "cluttered" lifestyle, simplification and overall reduction.

Although the article is about scientific research examining hum an behavior and irrational decisions - for example, choosing to "keep our options open" even while doing so hinders effective decision-making - we were struck by some familiar themes echoed throughout the article. The Times notes:

"We may work more hours at our jobs," Dr. [Dan] Ariely writes in his book [Predictably Irrational], "without realizing that the childhood of our sons and daughters is slipping away. Sometimes these doors close too slowly for us to see them vanishing."

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