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December 01, 2008 at 02:00 AM
As prices for raw materials fall and consumers look for bargains, certain industry sectors, sub-sectors and companies are poised to benefit, equity analysts say.
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Alexia [email protected]
U.S. Food: After six years, commodity cost inflation looks set to ease: Food companies look poised to see significant relief as year-on-year dairy inflation has already fallen below zero in recent months.
Class 1 milk prices have dropped to $15.53 for October [as of October 13], which represents a 28 percent year-on-year decline, and cheese price inflation on the spot markets is now negative. Wheat is by far the most important grain input for the U.S. packed food companies, since wheat flour is used in many different categories including cookies and crackers, cereals, refrigerated doughs and waffles.
Year-on-year wheat inflation on the spot market has now turned negative for wheat after spiking to $10 per bushel at the end of August 2007. Today, wheat prices are sitting at just over $7 per bushel.
If history repeats itself, a recovery in margins could be quite quick: Historically, the U.S. food group has tended to outperform the S&P 500 as commodity costs have moderated. In years when commodity cost pressures ease, gross margins have expanded quickly, for example, in 1981-82, 1985 and 1990.
Whenever commodity costs rise sharply, as they did in 2007, companies are often locked into promotional price points with retailers for some period of time, perhaps as long as four to five months in some categories.
The companies, therefore, experience a period where they are bearing the brunt of input cost inflation, but are unable to take pricing to compensate for this. As a result, margins typically get most compressed when commodity costs first begin to rise, but this effect is reversed once the anniversary of the initial input cost increase is reached, creating a “sweet spot” of rapid margin recovery.
The top line should remain strong for the U.S. packaged food group, although “trading down” will likely suppress volume growth: In contrast with investor concerns, we do not expect a sharp slowdown based on our analysis of the market data, since:o Branded packaged food companies have not seen a significant slowdown in dollar sales growth momentum, despite the recent acceleration in price growth.o Price elasticity of demand remains low.o Although we are seeing share losses for some companies, these have been modest and generally more than offset by strong category growth. o For many categories, we are actually seeing an improvement in volume trends once the anniversary of the initial price increase in the category is reached.
In 3Q08, we expect strong earnings results from Kraft Foods and Dean Foods, with weaker results for Sara Lee, Kellogg and Hershey. In general, we expect strengthening performance among the packaged food companies, especially among those that have seen significant margin pressures in the past year from rising dairy costs. However, we expect continued weak performance from Hershey. We rate Dean Foods, Kellogg, Kraft and Sara Lee Outperform with target prices of $31, $63, $41 and $18 respectively. We rate Hershey Underperform with a target price of $31.
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Andrew LazarBarclays [email protected]
Food: Perhaps the most important takeaway from our updated commodity-cost analysis is the sizeable directional shift in inflation from ’08 to ’09. While ’08 levels of inflation remain quire onerous despite the recent easing in key inputs, our early take on ’09 pains a much more moderate (1.2 percent) inflationary picture.
Specifically our early estimates for ’09 suggest inflation at a much more moderate pace of around 1.2 percent. … [I]t’s clear to us that ’09 is setting up to be a year of much more modest inflation for the group than the food industry has seen in the last several years, but still inflationary nonetheless.
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