Blame the weather, blame the government, or blame the producers. No matter who's to blame, the reality is that food production costs are rising, and Americans will likely see their grocery bills rising as the nation's largest food producers like PepsiCo (NYSE: PEP ) and Dean Foods (NYSE: DF ) try to hold onto otherwise diminishing margins.
Blame mother nature
For northerners in the middle of one of the coldest winters on recent record, it should come as little surprise that the fruit-and-vegetable-producing southern states have encountered challenging growing conditions through the winter months. Among the most notable victims is Florida's orange harvest, which has been faced with disease and dry weather that has led to expectations of a lighter harvest and in turn has spurred an increase in orange juice futures prices. Likewise, drought conditions in California could greatly affect many of the state's major crops and commodities, ranging from milk and beef to avocados and almonds.
Sadly, the problems have not been contained to just the U.S., as the world over has been witness to extreme weather conditions that have hurt harvests and will be felt by consumers. You may have already seen the effects at the grocery store a few weeks ago if you were planning a big Cinco de Mayo celebration: You either had to forego the limes or fork over relatively big money to buy them. On a much greater scale affecting global food production is the decline in corn production in China due to drier than usual conditions. Both at home and abroad, food producers and consumers will soon become intimately aware of the latest impacts of Mother Nature's unpredictability.
A chain reaction that will be tough to reverse
Agriculture and the food industry are naturally dependent on weather and seasonal fluctuations, though the breadth of the current worldwide weather impact is greater than in recent years, which have seen mostly isolated concerns in various regions in the U.S. and internationally. Starting with a late corn harvest in 2013, ongoing weather-related issues have pushed natural gas and propane prices up in-line with the rising futures prices of orange juice and milk. International demand has joined the weather issues to push up milk prices in particular.
Consumers may not have seen a substantial increase in milk prices, but as Dean Foods and other major dairy product producers see their margins pressured, the cost will end up being covered by consumers. Dean Foods struggled in the first quarter due largely to high raw milk prices, which led to a net loss in the quarter despite net sales that increased compared to Q1 2013. As the nation's largest processor of fluid milk, the continuation of high milk futures pricing will weigh on the company's yearly guidance, which was drastically reduced over continued pricing and margin concerns.
Coca-Cola (NYSE: KO ) and PepsiCo may find themselves in similar situations as rising orange juice futures could cut into juice production margins. As the world's largest juice and drink companies, both Coca-Cola and PepsiCo are especially dependent on the Florida orange harvest, and consequently they are especially subject to rising orange juice futures prices that cut into the margins of their premium products. PepsiCo's Tropicana Company is the single largest buyer of Florida fruit, and with a recent push to source all of the juice in its Pure Premium orange juice from Florida, it is likely to feel the effects of dry Florida weather well beyond the current quarter.
Food producers have seemed hesitant to respond to rising operational expenses with price increases that will hit the consumer, but that will be quick to change as earnings reports across the industry continue to indicate a trend of tightened margins. Though not always the case, it seems as though the consumer price index is set to rise in line with the producer price index, which equates most simply to higher prices for consumers at the grocery store. If or when the weather becomes more cooperative and commodity prices drop for the producers, I wouldn't expect major food producers to revert back to the low prices that have pinched their margins over the past year. In other words, higher food prices are on their way, and they won't be leaving anytime soon.
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