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Kraft Heinz: Will Customers Accept Higher Prices?

Inflation ticked up a huge 7% in December 2021, the highest level since 1982. You've probably felt the sting as you head out to live your daily life and been forced to pay more for just about everything. Kraft Heinz (NASDAQ: KHC), just like all of its food maker peers, is part of the problem, as it has been working to pass the rising costs it is facing on to consumers. For investors the big question here is, how is this process going?

Just the normal trend

The world is in an unusual time period, with the coronavirus upending business in many ways. For food makers, the pandemic brought increased demand as people shifted from eating out to eating at home more often. On top of that, there have been supply chain disruptions that have created problems with production and distribution, effectively increasing costs for everything from basic ingredients to shipping. Although this is a vast simplification of the global upheaval, the end result has been a swift rise in costs for companies like Kraft Heinz.

Image source: Getty Images.

While the current rise in inflation has been fairly acute, from a big-picture perspective, dealing with rising costs isn't that unusual for a company like Kraft Heinz. There's a fairly well-honed playbook for passing costs on to customers, including simply jacking up prices and adjusting package sizes, among other things. The real problem is that rising costs generally hit the company's bottom line before it can actually pass the costs along. So there's normally a bit of a margin squeeze in the near term before things even out over the longer term.

The current situation is different in that prices have continued to rise and food makers have been forced to push through multiple price hikes. The problem here is that it could create fatigue among consumers who might start looking for alternatives to their normal products in an effort to save money -- which is why investors should be digging into the numbers to see how Kraft Heinz is doing as it looks to pass on its rising costs.

A deeper dive

The key figure here is organic sales, which basically looks at the core business stripping out things like divestitures. On the surface, Kraft Heinz is doing fairly well, with organic sales through the first nine months of 2021 up 0.5%. Essentially, as the company has been raising prices it has been able to generate more revenue.

But there's a deeper level that you need to consider, because there are two main components to organic sales -- price and volume. As a price rises, volume tells you how well or poorly consumers are accepting the price hike. The numbers aren't looking good for Kraft Heinz right now.

In the United States, the company reported organic sales growth of 0.3% through the first nine months of 2021. However, that was composed of 1.3 points from price increases and a 1 point decline in volume. In other words, Kraft Heinz raised prices, and it led to a drop in demand. That's not a good sign if inflation remains high and the company has to keep increasing what it charges.

Kraft Heinz Organic Sales Growth -- First Nine Months of 2021

Market

Price

Volume

Total Organic Sales

United States

+1.3 points

-1 point

+0.3%

International

+2.1 points

-0.3 points

+1.8%

Canada

+2.2 points

-3.4 points

-1.2%

Total:

+1.5 points

-1 point

+0.5%

Data source: Kraft Heinz.

The problem is that the U.S. market wasn't at all unique. The same trend held true in the company's international division, with organic growth of 1.8% driven by a 2.1-point increase in price and a 0.3 point drop in volume. The Canadian group, however, bucked the trend in a bad way, with organic sales off by 1.2%. The components of that were 2.2 points of price increase more than offset by 3.4 points of volume decline. Clearly, Canadian customers chose to seek out other food options as Kraft Heinz raised its prices.

Basically, the top-level view (organic sales growth) is actually hiding concerning trends when you look at the dance between price hikes and consumer demand.

Watch these numbers

When Kraft Heinz next reports earnings, don't simply look at the top-level organic sales growth figures. They don't tell you enough to really understand what is going on as management attempts to deal with the impact of inflation. Indeed, price hikes have an impact, and if volume continues to fall off, the company may be forced to pull back on price hikes and accept reduced profit margins for longer. If that happens, investors would likely be displeased and act accordingly with regard to the stock.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Kraft Heinz. The Motley Fool has a disclosure policy.


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