H. J. Heinz Estimating the Cost of Capital in Unsure Times

H.J Heinz: Estimating the Cost of Capital in Uncertain Times

Fall 2018

Introduction

        The purpose of this report is to determine the Weighted Average Cost of Capital (WACC) for H.J. Heinz Company in 2009 and 2010. 2008 was a tumultuous time in our economy, as it began to enter into a recession. Heinz, and the food processing industry as a whole, were able to combat the recession due to the notoriety and sustainability of its products. Market Risk Premiums were at a low, much to the arguments of analysts, and Heinz must determine whether to adjust its forecasts to reflect the impact of the recession and other factors. The key calculation of interest is the WACC, due to its role in discounting cash flows for the horizon period. Adjusting the WACC would either raise expectations of Heinz’s performance, or lower those expectations with a higher discount rate. Any adjustment to the WACC must be based upon each of qualitative, quantitative and comparative analysis.

To determine if Heinz’s WACC needs adjustment and how that adjustment is made, the report explores the following key areas: A description of the food processing firm H.J. Heinz Company, an evaluation of the economy and industry during the time of recession and the factors that it influences, a methodological explanation and determination of Heinz’s Weighted Average Cost of Capital, comparison of the key variables concerning this calculation to other comparable firms, and a conclusion of what WACC we are going to utilize for the company. A Reference List and Appendix section are provided for your convenience.

H.J. Heinz: Brief Description

        H.J. Heinz Company (referred herein as “Heinz”) is an United States based organization in the Food Processing sector. Founded by Henry John Heinz in 1869 in Pittsburgh, Pennsylvania, Heinz is a global enterprise with presence in more than 200 countries. The company is at the forefront of food processing brands, boasting 150 products that are at the top of sales across the world. Its number one product, Heinz Ketchup, has a 50% market sure in the United States alone. With its slogan “57-Varieties” originally marketed for the variety of its pickles, Heinz utilizes the slogan now to market the variety of products it has.  The company was organized into business segments based primarily on region: North American Consumer Products, U.S. Foodservice, Europe, Asia Pacific, and Rest of World. About 60% of revenues were from outside the United States and the North American Consumer Products and Europe segments were of comparable size.  Increasingly, the company was focusing on emerging markets, which had generated 30% of recent growth and comprised 15% of total sales.  

Heinz has been largely absent from the field of mergers and acquisitions, as Henry J. Heinz chose to keep it as a family business until taking complete control in 1988 when he bought out his partners. In 2001, Heinz acquired its first company, Borden Foods, for its pasta and soup business and since has expanded to become one of the largest food processing companies in the world (“Heinz Ketchup”, n.d.).

The WACC Dilemma

At the end of 2010, financial analysts for Heinz disagreed on the company’s weighted average cost of capital (WACC). Heinz stock price went from $47 in 2008 to $34 in 2009, back to $47 in 2010. Interest rates also remained low for longer periods than typical. With the recession factors, the market may also be less willing to take risks. Resulting from these key points is that Heinz needs to adjust the weight of debt and equity in its WACC calculation. However, analysts feared that a lower discount rate would create favoritism towards starting new projects. We determine in this report if Heinz should adjust its WACC, if the adjusted WACC should be utilized in favor of comparable firms and the industry average, and why that decision is made.

Economic Outlook and Industry Health

According to 2008 H. J. Heinz Company Fiscal Annual Report, Heinz’s sales were up from

$ 9,001,630 in 2007 to $10,070,778 in 2008.  Despite the recession, sales were up due to consumers cooking and eating more at home, which increased their product demand.  According to William R. Johnson Chairman, President and Chief Executive Officer, Heinz had a record fiscal year in 2008, with sales at $10.1 billion. With increases in commodity and energy costs, this was an impressive feat. The report states the company’s momentum was broad based, with sustained success in North American Consumer Products, robust growth in the Pacific, good performance in Europe, and a 25 percent increase in Emerging Market sales.

Heinz’s growth is determined by how well the brand innovation and marketing investment connects with consumers. On this score, it was very successful, introducing more than 200 new products across the Heinz world in Fiscal 2008, supported by a double-digit increase in marketing investment. Consumers enthusiastically embraced the initiatives resulting in a strong top-line performance.  Heinz has successfully repositioned the company for faster growth.  Over the past five-plus years, the focus of Heinz is around the brands, categories, and geographies where it has a clear competitive advantage to enable faster growth in a rapidly changing landscape. Heinz expanded their presence in the fast-growing Emerging Markets, including joint ventures in China and Russia in 2004 and 2005, respectively, which are both now wholly owned and growing faster than the Company average (Team, 2011).

Sixty percent of Heinz’s portfolio comprises Health & Wellness products, a segment that is growing at nearly twice the industry rate. Heinz excelled amidst a credit crisis and the worst recession in decades, confirming the quality of the businesses and brands and the capabilities of the people. Heinz achieved virtually all of its financial targets for the year despite weak economies in the U.S. and Europe (“Heinz Ketchup”, n.d.)

Even though the measure of food shipped to retailers increased in 2009 and 2010, Heinz was proud to fiscally report that it delivered record sales of $10.5 billion, as well as record gross profit of $3.8 billion and record operating free cash flow of almost $1.1 billion in Fiscal 2010. Heinz’s excellent results reflect increased innovation and marketing behind its leading brands and dynamic growth in Emerging Markets, where new middle-class consumers are discovering the premium quality, taste, nutrition, convenience and value of its branded foods (Team, 2011).