Surging Crop Prices Could Cause Big Drops In These 3 Food Stocks

Includes: BNNY, HAIN, TSN
by: Hawkinvest

A perfect storm is causing food prices to spike around the globe. The combination of unseasonal rains in Brazil, production problems in Russia, and a major drought in the United States are responsible for a 45% surge in corn since May, higher prices in soybeans, wheat which is up about 32%, as well as increases in other grains. Sugar has jumped about 12% due to rains in Brazil, and the effects of this are soon to be felt by almost every company and consumer as higher prices cascade through the "food chain". Corn is widely used in the U.S. as a main ingredient in many food and drink products, as feed for livestock, and even for fuel. Therefore, a 45% rise will impact the economy in many ways.

A recent CNBC article summarizes the magnitude of the problem. It states:

Farming areas in the grain belt have been hit with scorching temperatures and extreme dryness, which have damaged crop production and sent corn prices surging about 45 percent in the past two months. Soybean and wheat prices have also seen large jumps. Such an increase is likely to impact the costs of everyday food items, from breads to meat products that come from grain-fed animals. 'Corn prices, in particular, are likely to feed through into a whole host of processed food prices, including various animal proteins, as well as anything using corn syrup sweeteners,' state economists at Bank of America Merrill Lynch.

While the impact of surging food prices has not trickled through the entire supply chain yet, it appears to be only a matter of time before it does. Whether a company produces meat, conventional foods or organic foods, input costs are rising and that is a fact that businesses and investors will soon be reconciling. With that in mind, here are three food companies that could be significantly impacted in the coming quarters by rapid rise in food prices:

Tyson Foods Inc. (NYSE:TSN) shares have been heading lower and it has been one of the first companies to state it will be impacted by the drought and rising corn prices. That is probably why the stock has dropped about 25% in the past 5 weeks. Tyson produces, markets and distributes chicken, beef, pork and other food products. The company processes carcasses into case-ready products for consumers. It also offers prepared foods such as pizza, corn tortilla products, appetizers, soups, etc. Tyson sells its products to a wide variety of grocery stores, restaurants, and warehouse club stores. Since corn is a major feedstock for chickens, cows and pigs, this company is likely to be impacted with the meat it sells. It also appears to have exposure to rising grain prices since corn, wheat and other grains are used in pizza and tortilla products. A recent third quarter press release, dated August 6, 2012, from Tyson, was one of the first from any major food company to acknowledge the challenges and price increases that are coming for the food industry, it states:

Grain costs have been increasing significantly and rapidly, largely as a result of the on-going U.S. drought. While we ultimately expect to pass along rising input costs, these costs, coupled with continued soft demand, are likely to pressure earnings in 2013.

Although Tyson shares are now close to 52-week lows, the stock might remain under pressure until more clarity arises on earnings in the next couple of quarters.

Here are some key points for TSN:

  • Current share price: $15.56
  • The 52 week range is $14.07 to $21.06
  • Earnings estimates for 2012: $1.82 per share
  • Earnings estimates for 2013: $1.61 per share
  • Annual dividend: 16 cents per share which yields 1.1%

Annie's, Inc. (NYSE:BNNY) shares have not seen a major drop yet, but it is hard to imagine that this company won't be impacted soon, especially since it relies on other companies to manufacture products for it. Just as Tyson Foods stated it would seek to pass rising food costs onto others, many of the food companies that manufacture for Annie's might do the same. This company offers products, including pizza, macaroni and cheese, pastas, granola bars and other snacks that are likely to be impacted by the rise in food prices.

Annie's IPO prospectus has disclosures that investors should consider as a major potential risk to profit margins as page 16 states:

We derive all of our sales from products manufactured at manufacturing facilities owned and operated by our contract manufacturers. During fiscal 2011, we paid $45.0 million in the aggregate to our top three contract manufacturers. We do not have written manufacturing contracts with all of our contract manufacturers, including Lucerne Foods, one of our top three contract manufacturers that manufactures several of our top selling products.

This could be a concern for two reasons: One is that Annie's uses contract food manufacturers, and those companies are almost certainly going to see the impact of the huge rise in corn, soybeans, wheat and other grains. Chances are strong that some, if not all, contract food manufacturers will pass on rising costs to customers like Annie's. An across-the-board price increase might make sense for contract food manufacturers. That means profit margins for companies like Annie's could be impacted if prices are raised due to higher manufacturing costs.

The second concern is that Annie's states it does not have written contracts with a number of its contract manufacturers, including Lucerne Foods, which is one of the largest contract manufacturers for Annie's. If Annie's was manufacturing food itself, it might have greater controls over input costs. If Annie's had written contracts with all of its contract manufacturers, and especially the largest ones, like Lucerne Foods, it would probably reduce the risk of a sudden jump in prices that food manufacturers are likely to pass on to customers like Annie's soon. If you don't manufacture your own products or have written contracts with all the companies that do, the ability to control rising costs seems quite limited.

Food companies can try to pass on higher prices, but if other competitors choose to keep prices down, or if consumers buy less because of price hikes, growth could flatten along with a squeeze to profit margins. Food stocks like Annie's that trade at incredibly high price to earnings ratios of about 50 will have a long way to fall if earnings or revenue growth stalls, as I expect it will given the rapidly changing environment for food prices.

Aside from a major new challenge with rising food costs, and a sky high price to earnings ratio, investors should not ignore the heavy amount of top-level insider selling at Annie's. On August 5, 2012, the CEO, John Foraker sold nearly $400,000 worth of stock, and on the same day, the Chairman, Molly Ashby, sold over $129 million worth of stock, which is the second major sale in months, since she also sold about $83 million worth of stock in April 2012. With over $200 million worth of insider selling in this relatively small company, investors should follow the cues of the CEO and Chairman and sell before the potential impact of the U.S. drought hits more food stocks.

Here are some key points for BNNY:

  • Current share price: $42.26
  • The 52 week range is $31 to $45
  • Earnings estimates for fiscal year 2013: 82 cents per share
  • Earnings estimates for fiscal year 2014: 98 cents per share
  • Annual dividend: none

Hain Celestial Group, Inc. (NASDAQ:HAIN) shares have been in a nice uptrend, but the stock has started to show signs of weakness. The stock recently closed at $53.76, which is just below the 50-day moving average of $54.64. This could be an early sign that the stock is ready to break lower, and it probably should as the market becomes more aware of the profit margin and guidance risks food stocks are potentially faced with in the coming months. This company has numerous brands with products that widely use corn, flour, sugar, grains and other basic ingredients, which have recently surged in price. For example, the "Arrowhead Mills" brand offers mixes, grains, cereals, etc. "Deboles" offers a range of pasta products, "Hain Pure Foods" offers crackers, cookies, rice cakes, and other snacks. The company owns other brands and offers other food products that use corn, wheat, sugar, etc., many of which could be impacted by the rise in these key ingredients.

While this stock does not appear to be anywhere nearly as overvalued as Annie's shares, it could be poised for a sharp drop as well, if profit margins are squeezed. Even if the company reports a decent quarter, investors should look ahead and consider that guidance might be weak due to the rising food costs, and that could also take the shares down sharply from recent highs. If this company becomes one of the first "natural" foods companies to talk about the impact of rising food prices when it reports earnings and guidance on August 22, it could take down other natural food stocks as well.

Here are some key points for HAIN:

  • Current share price: $53.76
  • The 52 week range is $27.48 to $58.31
  • Earnings estimates for fiscal year 2013: $1.80 per share
  • Earnings estimates for fiscal year 2014: $2.09 per share
  • Annual dividend: none

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.