NEW YORK U.S. grain prices are soaring as the Midwest corn belt suffers its worst drought since 1956, but that doesn't mean grocery bills are about to jump.
Easing costs of other commodities, hedging strategies aimed at keeping corn costs in line and fears of turning off consumers in a weak economy should all keep packaged food companies from hiking prices, at least in the short term.
"The spike is isolated, and thank goodness it is, because these companies have no room for pricing," said Edward Jones analyst Jack Russo.
Corn is a main ingredient for everything from livestock feed and sweetener to tortilla chips and bourbon. Corn futures have soared some 46 percent since early June as oppressive heat and the worsening drought stoke concern about food and fuel price inflation. Soybeans and wheat are also up dramatically.
U.S. Agriculture Secretary Tom Vilsack said this week that rising prices would mean higher meat prices, though the inflation might be delayed as farmers cull their herds due to high feed costs.
High corn prices might normally squeeze profit margins for loads of companies ranging from Hormel Foods Corp (HRL.N) and Kellogg Co (K.N) to Ralcorp Holdings Inc RAH.N and PepsiCo (PEP.N).
But in this case, the price spike is limited to grains, and has not affected other key commodities like fuel and metal, which signals that widespread increases across packaged food are less likely.
In fact, Coca-Cola Co (KO.N), which reported second-quarter earnings earlier this week, actually lowered its expectations for the how much commodity costs would rise this year. It now expects a $300 million increase, down from its prior forecast of $350 million to $450 million, even though it uses huge amounts of high-fructose corn syrup to sweeten its drinks.
"It was known what corn was when we made that statement," Chief Executive Muhtar Kent told Reuters in an interview following the revision. "It's not like we said we were looking at $300 million and now it's $150 million, I wish it was."
Coke is also a big buyer of fuel, plastic, aluminium and coffee, all of which are less pressured than before.
"When you look at the combined forecast, we're slightly tempering that," he said.
Last year, when corn prices doubled and almost all commodities skyrocketed on growing demand from emerging markets and macroeconomic uncertainty, Coke had an $800 million increase in commodity costs.
Right now, about 80 percent of packaged food companies have lower overall commodity costs compared with last year, according to Janney Capital Markets analyst Jonathan Feeney, due to steep declines in other ingredients like sugar, cocoa, peanuts and durum wheat.
Hedging, or locking in prices early, also helps protect companies from market volatility. Increased volatility over the last several years has led many companies to adopt more sophisticated hedging strategies.
General Mills (GIS.N), maker of Cheerios cereal and Pillsbury products, said this month that the corn spike did not change its outlook for commodity inflation or prices.
The company is about 50 percent hedged on commodity costs for the year, and expects increases of just 2 percent to 3 percent, compared with a jump of more than 10 percent last year.
Despite General Mills' roots as a flour miller, grains now account for only 5 to 10 percent of its total costs, since it sells other things like Haagen-Dazs ice cream and Green Giant vegetables.
"Consumers should see generally stable prices," CEO Ken Powell told Reuters in an interview on July 10.
THE POWER OF PRICE
Companies do not usually reveal details of their hedging strategies, which means that knowing exactly how much rising prices of any commodity can hurt them is difficult.
Several companies contacted for this article declined to comment on their corn hedging, or the impact they would see from the spike, citing "quiet periods" ahead of upcoming earnings reports.
Yet for a typical packaged food maker with a gross margin of around 40 percent, a 1 percent increase in retail prices will offset roughly 5 percentage points of cost inflation, Feeney said.
"A little bit of headline pricing goes a long way," he said, noting that a doubling of input costs could be cushioned by just a 20 percent rise in prices.
Therefore the current inability to raise prices, due in part to weak consumer spending, should be a bigger consideration for food companies than the fact that some of their ingredient costs are lower, Feeney said.
To be sure, for meat companies like Smithfield Foods Inc SFD.N and Tyson Foods Inc (TSN.N), which are more commodity-driven, the math is different, he said.
Producers of chicken, pork and beef could all be forced to raise prices as feed costs rise, said Sterling Smith, vice president of commodity research at Citibank's Institutional Client Group.
"What I would be most concerned about is livestock down the road," Smith said.
As animals get more expensive to feed, Smith said they will get sent to market younger and smaller. That can boost the near term supply of meat, but it hurts supply later, when the animals would normally have come to market.
"Maybe you send (a cow to slaughter) at 800 lbs instead of 1200 lbs. That takes 400 lbs out of the market, but brings 800 lbs to the market sooner. So you see more slaughter ... then when we get to where those animals should be in the normal cycle, they're not there," he said.
Because of relative differences in how long it takes animals to reach maturity, Smith said he expects to see a price impact in chickens in about three months, pork in four to six months, and beef in about six to eight months.
It is still too early to call exactly what will happen with prices, since the drought and growing season are not over. But if the drought continues, and prices remain this high, cost-conscious carnivores may have few options for low-priced meat.
"I find it hard to believe that this magnitude of increase in costs, should it be sustained, won't lead to draconian cuts in supply and very strong pricing across all three meats, in which case there's not much to trade down to," Feeney said.
(Editing by Leslie Gevirtz)
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