Skyrocketing Food Prices Rock Companies’ Margins

Food companies will now have to increase marketing spending to support sales volume--can they remain profitable?

May 28, 2014 at 9:07AM

U.S. food commodity prices have been soaring in recent months, which is likely to challenge food companies' margins and sales volumes in the near term. Input cost inflation pressures have forced many food companies to increase prices to protect their top-lines and margins.

Rising commodity prices
Food companies Kraft Foods (NASDAQ:KRFT), Dean Foods (NYSE:DF), and Hillshire Brands (NYSE:HSH), with exposure to dairy and meat products as well as coffee beans, are being challenged by increasing food commodity prices. Coffee bean prices have increased about 65% year to date because of a drought in Brazil, as the country contributes a significant 35% to the world's coffee production.

In addition, meat product prices have surged by 20% year to date, as PEDv (a virus) resulted in a supply shortage. Raw milk prices have been on the rise in recent quarters because of growing export demand from Asian markets. In 2013, U.S. dairy product exports were up 19% year over year. Prices for dairy products in the U.S. have grown by about 20% year to date.

Sales volumes to be challenged
In response to rising commodity prices, Kraft has decided to increase prices across 45% of its product portfolio to support margins in the current environment. The company raised prices for its cheese portfolio in a range of 5%-12% since March and announced a 10% price increase across its Oscar Meyer cold-cuts segment by the end of May.

Kraft has yet to announce a price increase for its coffee portfolio, which is expected in the ongoing second quarter or early third quarter of 2014. The price increases intended to address commodity inflation and protect margins could challenge the company's sales volume. Also, it might impact the company's market share in the short term.

However, Kraft needs to increase its advertisement and marketing spending to support its sales volume in response to price increases. Also, Kraft's efforts to improve productivity and expand margins will help to offset the impact of commodity-cost inflation and price increases in the medium-to-long term. In the short term, the company's sales volume and margins might be challenged.

Dean Foods, the largest U.S. milk processor, is another company that has been facing challenges because of rising dairy prices. Raw milk prices have reached an all-time high, increasing 22% year over year in the first quarter of 2014. Also, higher milk prices have adversely affected fluid milk volume in the U.S., which dropped by 2.1% in the first quarter of 2014. Higher commodity prices and competition have been negatively affecting Dean Foods' performance in recent quarters.

In the first quarter of 2014, Dean Foods' total sales volumes were down 5.9% year over year. Also, the company's gross profit dropped by 16% year over year to $416 million, and adjusted earnings per share declined by 116% year over year to a loss of $0.05 in the first quarter of 2014. Moreover, because of rising raw milk costs, the margin between the Class I mover and retail price contracted to $1.43 per gallon in the first quarter of 2014, down from $1.58 in the first quarter of 2013.

Input costs continue to be a headwind for Hillshire. So far, the company has effectively managed through consistent and acute inflation; in the first quarter of 2014, Hillshire experienced sales and operating margin growth of 3.4% and 10.1% year over year, respectively. The company has been increasing product prices to offset the impact of input cost inflation and has signaled that additional pricing actions are required in upcoming quarters. As pork retail prices increased to a record high of about $2 a pound in March as compared to $1.40 in the corresponding period last year, the company increased prices on Jimmy Dean sausage and Ball park hot dogs.

Despite this fact, Hillshire observed sales growth in the recent first quarter; sales volumes were down 3.2% year over year. As the company continues to increase the prices of its products in the current inflationary environment, this continues to adversely affect sales volume and could also impact the company's margins.

Final take
The current situation of rising commodity prices remains a headwind for companies, as price increases could in response challenge sales volumes in upcoming quarters. In the current industry environment, marketing and advertisement spending needs to be pumped up to support sales volume growth. The rising costs and marketing initiatives adopted by companies are likely to keep margins under pressure in the short term.

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