How To Offset Rising Food Costs

by: Stock Traders Daily

By Dennis Hobein, Stock Traders Daily

Consumers are getting hit by a triple-whammy these days: stagnant (actually, declining when adjusted for inflation) wages, rising gas prices, and rising foods costs. Today, I want to focus on that last concern as I believe rising food costs are going to increasingly become a problem this year and into 2013.

It isn't just a figment of one's imagination either - the numbers prove that buying food has become more costly. According to the Food & Agricultural Organization (FAO), its food price index is at its high point of the year, and lagging only 2008 levels, when surging food costs caused riots across the Middle East and Northern Africa (not unlike what we are seeing today, by the way).

The causes for the spike in food prices are numerous. The corn-belt has been suffering through the worst drought in over 50 years, launching corn and soybean prices to record highs. Unfortunately, just as the U.S. was going through its drought, so were parts of Russia and other countries in the Black Sea region. These droughts, combined with rising fuel costs and growing populations, particularly in Asia, have created a perfect storm.

But, just like pretty much everything else, the stock market has looked past this consumer-pinching problem. Since early June, when food prices really began ticking higher, the SPDR S&P 500 ETF Trust (SPY) is up 13%. With SPY hitting, and being rejected by resistance at the $147-$148 level, and with a (most likely) weak Q3 earnings season coming up, the broader market may finally be ready to come back to reality a bit.

Beyond this upcoming earnings season, though, these rising food costs could begin to ripple through corporate profit lines, and ultimately, the stock market. The senior economist at FAO recently commented that, "It is highly unlikely we will see a normalization of prices any time soon."

So, why does this matter for stocks? Well, because manufacturers and producers will undoubtedly look to pass these increased costs onto customers, who are ill-equipped to handle any price increases. Here is a fact: Since reaching a peak in October 2010, real average weekly earnings have fallen steadily, now lower by 1.3%. This, at the same time that gas prices have increased by 38% since October 2010, and food prices, according to the FAO's Food Price Index, has crept higher by roughly 17%. In other words, companies are going to be met with a lot of resistance from consumers.

For the broader markets, this is another concern to add to the list. The good news is, there is a way to protect, and even profit, from this. One stock to avoid, and maybe even short should it break its $48 support level, is Starbucks Corporation (SBUX). Not only will some consumers begin to scale back on their morning runs to SBUX, and maybe settle for something home-brewed, but the one component in the price index that saw the largest increase in September was dairy (up 7%). Milk and cream, of course, are ingredients in many SBUX drinks and the company will soon be paying more for those ingredients.

Another name to avoid & possibly short is Panera Bread Co (PNRA). The bakery-café chain has already lifted menu prices this year, and faces the likely decision of whether it should raise prices again, at the risk of driving some traffic away, or, taking on the higher commodity costs and crimping its margins. It is interesting to look at side-by-side charts of Chipotle Mexican Grill, Inc. (CMG) and PNRA. Both companies are facing the same issues, but, shares of CMG have tanked by some 30% since early June, while PNRA is up 12% during this time. Sure, they have different menus and different business models, etc., but, that is a massive divergence. I'd also point out that PNRA has a rich valuation with a trailing P/E north of 32x.

If shorting isn't your forte, there are a couple ways to play the rise in food costs from the long side. Your tradition grocery chain is going to have trouble passing these costs on to their customers, but cost-leading companies like Wal-Mart Stores, Inc. (WMT) should benefit. A combination of a more efficient operation, allowing for it to better absorb higher input costs, and the possibility for a bump in traffic as customers migrate from traditional grocers should work in WMT's favor.

Another idea is to buy agriculture stocks, such as Monsanto Company (MON). This company provides seeds and herbicides to farmers, helping them to increase their yield. In a time when farmers have seen their crops get decimated by the destructive drought, MON's products should be in high demand come planting season. From a broader perspective, MON and other ag companies are poised, in the long-run, to enjoy strong demand due to population growth in countries like China & India, and a decreasing amount of arable land.

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

Business relationship disclosure: Written by Dennis Hobein, Contributor to Stock Traders Daily.