"What's quite clear is that consumers will be paying more for food and more for energy and none of this is very good news for the overall economy if you're not in these sectors," said BMO Financial Group global portfolio strategist Donald Coxe.
---------------------------------------------------- Deere, Nestle raise new fear Inflation Rears Its Head Above Credit Crunch Sean Silcoff, Financial Post Published: Thursday, August 16, 2007
While you were fretting yesterday about the state of the subprime lending market and its effect on stock prices, two giant multinational companies released stellar results that boosted their stock prices, pleased their investors -- and gave everyone else something to really worry about.
Nestle SA stock roses 9.5% as the Swiss food company, the world's largest, posted stronger-than-expected first-half earnings largely on the strength of its food and beverage group, which includes a stable of 26 "billionaire" brands such as Kit-Kat and Nescafe, and announced a 35-billion-Swiss-franc ($22-billion) share buyback program.
Illinois-based Deere & Co., the world's top farm equipment maker, also surprised analysts with a 23% rise in net income and a 10% boost to its forecast profit for the year, driven by growing international sales of farm equipment. It too has begun a share buyback, its second in two years. Email to a friendEmail to a friendPrinter friendlyPrinter friendly Font:
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What does this tell us? Despite tightening of credit markets, the world economy is still strong, leading to a heavy wave of buybacks by profitable companies that see compelling value in their own stocks. Remember that outside Canada and the United States, the rest of the world is enjoying one of the most broad-based economic expansions in memory.
But below the headlines, the news from Nestle and Deere also confirms that after the chaos on financial markets dies down, there is an another, potent problem to contend with: inflation.
Let's start with Nestle. Its food and beverage group, which accounted for the vast majority of its 51.1-billion-Swiss-franc sales in the first half, enjoyed 7.1% "organic growth." Close to one-third of that increase came by raising prices, while in its largest division, dairy, Nestle increased the operating profit margin by an impressive 160 basis points.
But it did so by being slightly ahead of the game. Input costs for everything from milk to cocoa beans are rising fast; a chart supplied by Nestle shows that, after trading in a band of 70 to 90 for the previous seven years, an index of prices of relevant agriculture commodities have shot up in 2007, topping 130. "Input costs are becoming the major talking point in the industry this year," chief financial officer Paul Polman said. It's just that Nestle managed to pass through the cost increase to consumers before they showed up on its income statement.
But that will happen in the second half, and the first half of next year, leading to lower margins, he warned. It's the same story at other food companies: costs are going up, so they're passing them on to customers. If you haven't noticed it, take another look at your grocery bills.
That brings us back to Deere. The 170-year-old maker of farm equipment has been basking in the agriculture boom. U.S. corn plantings hit a record this year and total agriculture tonnage in Canada and the United States is expected to rise 63% in 2007. Not surprisingly, Deere expects sales of agriculture equipment to rise 16% in 2007, driven by strong global demand. The unit's operating income for the second quarter was up 73% to US$431-million.
Deere has been getting more sophisticated about the way it does business, cutting off under-performing dealers and selling ever-more sophisticated machines that CEO Bob Lane has described as "computerized factories on wheels." Those new machines are helping to increase yields on farmers' fields, not just in western markets but in such fast-growing economies as India and China, where farmers still do things manually. "The company is well-positioned to benefit from powerful, global secular economic trends," said Bill Ratzburg, director of investor relations.
But demand for agriculture commodities is rising faster than the offsetting productivity gains Deere's equipment can deliver, due to rising demand for better food in China and India and the burgeoning biofuel industry. That's great news for Deere, a wash for Nestle, and troubling for everyone else. "What's quite clear is that consumers will be paying more for food and more for energy and none of this is very good news for the overall economy if you're not in these sectors," said BMO Financial Group global portfolio strategist Donald Coxe.
