Food for thought: The price of food is on the rise, but investors should be aware that this global phenomenon doesn't affect all food companies the same way.
Cereal, salty-snack, candy, and beverage companies can most easily pass along their price increases. Firms dependent on luncheon meats, dairy products, and eggs have a harder time because their products aren't so significantly different from each other.
It is a hard fact of life for investors that what boosts the bottom line of a food company in which they own stock can also increase the prices they must pay in the grocery checkout line.
"Costs are going up, and food companies need a 4 to 6 percent retail price increase to cover increases already incurred," says Jonathan Feeney, food and beverage analyst with Janney Capital Markets in Philadelphia. "The number is even more significant for the grain-based companies, such as Kellogg in the breakfast segment, which need 6 to 7 percent retail increases."
Some companies are better-situated to deal with these consumer price increases stemming from factors such as deficit spending by governments, fast-growing emerging-market economies, and volatile commodities.
McCormick & Co. Inc. (MKC), a leading global maker of spices, herbs, extracts, and seasonings, is a Feeney stock recommendation.
The company experienced some commodity cost increases but not nearly as many as companies that must buy grains and sugar. Its acquisition of Lawry's several years ago eliminated a primary competitor, and it continues to launch new products. McCormick supplies not only grocery stores, but also industrial, restaurant, and packaged-food companies.
The more impulse-driven the food category and the lower the product price to begin with, the easier it is to get a price increase through, says Feeney. A 10-cent increase in a Hershey's chocolate bar won't prompt many complaints, while Kraft Foods is less able to pass along price increases because it offers a greater number of daily mealtime items.
"If we start seeing gas at the pump costing $4 or more, it will challenge consumers even further and increase the transportation costs for companies," says Ann Gurkin, equity analyst with Davenport & Co. in Richmond, Va. "The companies that are leaders in their segments have better relationships with retailers, so that's helpful, but no companies are going to escape these cost increases."
For increases that can't be fully passed along to consumers, companies offset them by cutting costs in areas such as advertising, she says.
The Hershey Co. (HSY), North America's largest confectionary manufacturer with 43 percent of the U.S. chocolate market, is a stock recommendation of both Feeney and Gurkin. Hershey's, Reese's, Kit Kat, and Twizzlers are some of the 80 brands that it sells in more than 60 countries outside the U.S. Cash flow is plentiful at this company that sells an affordable luxury.
Another Feeney choice is General Mills Inc. (GIS), the second-largest producer of ready-to-eat cereals in the U.S., because it has leading brands in so many segments and has a firm handle on cost increases and product pricing. Through a partnership with Nestle, it distributes cereal products in more than 130 countries. Its Cheerios cereal and Pillsbury brands are especially strong. Other brands include Betty Crocker, Haagen-Dazs, and Yoplait.
Raising prices is a tricky business.
"If there's just a few-percent increase in cost, this can be passed along via price increases, or you can change the package size and it won't be that noticeable to consumers," says John Toohey, vice president with USAA Equity Investments, in San Antonio. "The challenge is when cost increases become bigger than a few percentage points."
Food distributor Sysco Corp. (SYY) is a company that tried to raise prices and experienced a push-back with negative impact on sales volume, Toohey says. The firm's food inflation is running higher than the company's "sweet spot" profitability, he says. An investor should look closely at food companies with solid brands, global businesses, and strong balance sheets, he believes. The ability to launch new products is also important.
The two biggest nonalcoholic beverage companies fill that bill.
Feeney and Toohey recommend PepsiCo Inc. (PEP), maker of carbonated and noncarbonated drinks as well as a variety of snacks, largely because it can pass along price increases. The company's brands include Pepsi, Gatorade, Tropicana, Lay's, Doritos, and Quaker. It now owns most of its bottling infrastructure in North America, and distributes to stores internationally. It is the world's largest snack food company, with 40 percent of the U.S. salty-snack market.
Feeney also recommends Coca-Cola Co. (KO), the world's largest maker and distributor of nonalcoholic beverage concentrates and syrups. The company, which also sells a variety of noncarbonated drinks, has pricing power. Three-fourths of its revenue comes from outside the U.S. through brands such as Coca-Cola, Sprite, Dasani, Powerade, and Minute Maid. It now owns much of its North American distribution.
"Remember that a company's ability to pass through price increases is also a function of how strong its competitive position is and how strong the consumer desire for it is," says Feeney, whose firm suggests that investors also should look closely at shares of food companies Ralcorp Holdings Inc. (RAH), Fresh Del Monte Produce Inc. (FDP), Dole Food Company Inc. (DOLE), Treehouse Foods Inc. (THS), and Chiquita Brands International Inc. (CQB).