How food firms can benefit ? pass it on What's bad for consumers may be good for business David Berman, Financial Post Published: Wednesday, May 02, 2007
Inflation is emerging as a threat to central banks around the world, but some investors are noticing a stock-picking theme in the gathering clouds: Buy food companies and watch their profits and share prices soar.
Merrill Lynch has already pegged the theme as a winner, since food companies can pass along the rising input costs, or "agflation," to consumers.
"Agflation is bad news for the consumer, already under pressure from higher energy prices," said Jose Rasco, an investment strategist at Merrill Lynch, in a recent note. "For the food companies, however, it could be good news as many companies have been able to pass along those higher costs to the end user."
The recent performance of the S&P 500 packaged foods index certainly supports the idea. The 12-member index, which includes Campbell Soup Co., General Mills Inc., Kellogg Co. and Kraft Foods Inc., has risen 17% during the past 12 months and is close to a record high. Since mid-March, the index is up nearly 8%.
More specifically, Procter & Gamble managed to raise the price of its Folgers Gourmet Selections coffee by 5% in January to offset the increase in the price of arabica coffee. And Tyson Foods Inc. reported quarterly earnings that roared past analyst estimates this week and sent the meat producer's shares up to an eight-year high.
But this theme will work only if -- and that's a big "if " -- these companies can continue to pass along higher costs to consumers who are already dealing with a slowing economy and an uncertain housing market.
The U.S. Department of Agriculture estimates that food inflation, as measured by prices rising in retail stores, will increase 3.5% in 2007 after rising 2.3% last year. Food prices are already up 7.3% in the first quarter, on an annualized basis.
The reason is largely related to the surging demand for corn, as the United States promotes corn-based ethanol as a solution to its reliance upon crude oil imports from the Middle East. Corn prices recently soared to a 10-year high, creating similar price swings along the entire food chain.
Domestic animals that eat corn, such as chickens, are more expensive to produce. And with farmers shifting production toward corn, other crop yields are in decline. This has led to higher prices for commodities like wheat and soybeans. Mr. Rasco noted that the trend is global in scope and long-term in duration.
The problem with embracing this theme, though, is that it is ultimately the consumer who decides whether price increases are successful or not. The airline industry has noticed that it can pass along only so much of their rising fuel costs before consumers balk at the price increases. Then, airlines are left to absorb the costs themselves.
The food industry is in a better position, since consumers must buy food even as they say no to little luxuries like vacations abroad. But consumers can become selective shoppers, taking price into account over brand name, and leaving food producers in a competitive scramble that will see margins get compressed.
Like inflation, a little is OK -- but too much will be painful.
