SFD. Feed costs.
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Crop shortage seen likely to push food prices up
August 20, 2002 3:06:00 PM ET
By Deborah Cohen
CHICAGO, Aug 20 (Reuters) - The severe Midwest drought could spell higher retail food prices in the fall if rising commodity costs squeeze profit margins and force food companies to hike the price of their goods, analysts said.
Last week, the United States Department of Agriculture released crop projections for the fall harvest that were below already diminished expectations and sharply below year-ago levels. Corn production was seen at a 7-year low, soybean production at a 6-year low and wheat output at a 20-year low.
That could mean 1 to 3 percent higher prices in grocery stores on everything from meats to cereal and soda, as companies try to offset the impact of higher raw material costs, analysts speculate.
Food makers ranging from North American leader Kraft Foods Inc. (KFT) to cereal maker Kellogg Co. (K) may face a price spike for raw materials such as corn, soybean oil and wheat of more than 20 percent in the coming year, analysts said.
"Food companies have such little pricing flexibility, and given that ingredient costs have been benign over the past few years they may use this as a reason to take some pricing," said Goldman Sachs analyst Romitha Mally.
Mally said the increases could occur over the next several quarters, but that it was still too early to access any impact to earnings.
In addition to higher ingredient costs, shrinking crops spell a sharp rise in feed costs for companies such as poultry giant Tyson Foods Inc. (TSN), pork producer Smithfield Foods Inc. (SFD) and packaged meat producer Hormel Foods Corp. (HRL).
The price of corn -- the primary feed for meat animals -- is up 30 percent since mid-June at the Chicago Board of Trade. That has already prompted some farmers to cull herds, which adds to a meat glut currently but could push prices of animals up as the smaller supplies take hold in coming months.
HEDGING THEIR BETS
Most companies hedge their exposure to commodity price swings forward by a year or more using futures and by locking in fixed prices on contracts of everything from hogs to wheat. But they may not be adequately hedged to withstand the coming crop shortfalls.
"Competition remains keen in most of these businesses and we expect most commodity processor earnings to come through a drought with weaknesses," said Deutsche Bank analyst Eric Katzman.
Commodity-oriented food makers such as meat processors are more exposed to spikes than value-added packaged foods makers, with up to 65 percent of the cost of finished meat goods sold at retail tied to commodity costs, analysts said.
Even a small price increase can help to offset the added pressure on earnings. If Tyson raises wholesale chicken prices by a penny a pound, that could add 18 cents a share to its 2003 bottom line, said Merrill Lynch analyst Leonard Teitelbaum.
A Tyson spokesman was not immediately available to comment on pricing plans.
"I would expect that as more commodity-oriented companies report, we are going to hear about how this is going to affect quarters to be reported from September to the end of the year," Teitelbaum said. "We will begin to see more of the effect in the second quarter of the year, should the hedges run out."
Teitelbaum said he is anticipating across-the-board increases of 2 percent to 3 percent in the retail prices of poultry, pork and beef starting in the fall.
Packaged food makers such as Kraft, Kellogg and General Mills Inc. (GIS) face less exposure to the crop shortage, as commodity costs range from only 2 percent to 6 percent of the total cost of manufactured products.
More costly by far are packaging and promotional costs. Marketing, for instance, can be as much as 35 percent of the total cost of producing a box of brand-name cereal.
Depending on the category, analysts believe that they might see packaged food makers hike wholesale prices by 1.0 to 1.5 percent, attempting to pass those costs along to retailers.
Packaged foods makers are watching the trends carefully, but most are reluctant to comment on price increases.
"When grain costs rise as much as they have, we obviously have to be very concerned, and have to keep a very close eye on these costs," said John Renwick, a spokesman for Battle Creek, Michigan-based cereal maker Kellogg. REUTERS
