Record wheat, corn and other commodity prices are in all of the headlines. The "R" word also captures the daily headlines.
Under normal circumstances during an economic slowdown, defensive stocks like Kraft Foods (KFT), General Mills (GIS) and Kellogg (K) should be in vogue with rising stock prices.The theory has always been "everybody's got to eat", Right? Well, the world wide grain shortage has put that old adage into question. Stock pickers and the market are concerned that food companies will not be able to keep their margins intact nor able to raise prices fast enough.
When food companies are faced with rising commodities, they have three main weapons to combat margin erosion.
- First and the most obvious is to raise prices. In this environment, all companies are raising prices, so what matters the most is how are they priced relative to their competition.
- Secondly, food companies can implement productivity programs. This means cutting costs in other areas, such as reducing headcount or discontinuing unprofitable products or markets.
- Third, they can cut advertising expenditures. This tends to be a short term solution but it has the immediate benefit of improving the bottom line. It may hurt the long term strength of the brand, but for companies like Kraft and Kellogg, the brands are strong enough that 6 months or a year without large advertising expenditures will not necessarily hurt them.
So what does this all mean? Are food companies a good buy at this point? The answer is, it all depends. This where the food company executives earn their pay.
The best performing food companies will be those that use a combination of measured price increases, productivity and reduced advertising to offset rising commodity prices. We will also then be able to tell which companies have the strongest brands and the most loyal consumers.
I believe that the strong branded players will come out of this situation even stronger. Kraft, General Mills and Kellogg will make the necessary adjustments and have the strong brands to mitigate the minefields of rising commodities. More importantly, when commodities stablize and even "god forbid" decline after the next harvest, they will be left with stronger margins and fatter profits.
There will also be fewer weak players to compete them with them, leaving them in a stronger position.