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FOCUS: Food Processors To Benefit From Cheaper Grain Prices

04/17/2012 | 03:01pm US/Eastern
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--Flattening prices for grains, particularly wheat, should boost margins

--Historically wholesale prices don't go down

--The impact of lower or stable commodity prices should be more apparent in the second half of 2012

By Andrew Johnson Jr.

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Food processors such as Kellogg Co. (>> Kellogg Company) and General Mills Inc. (>> General Mills, Inc.) are expected to benefit from cheaper grain prices this year as retail prices continue to rise.

Flattening prices for grains, particularly wheat, should boost margins as companies look to grow profits rather than pass on savings to consumers.

Packaged foods wholesalers such as General Mills and Kellogg will reap the benefits of cheaper grain prices. Past performance indicates that wholesale prices to retailers will continue to rise by 2.5% to 3%, and this is expected to relieve stress on processing margins.

Historically, wholesale prices don't go down, as processors attempt to get margins back to where they were before commodity input costs escalated, said Brian Todd, president and chief executive of the Food Institute in Upper Saddle River, N.J.

Wholesale prices are poised to climb by 3% in 2012, after jumping 6.3% last year, he said.

Wheat futures are down 28% from a year ago, and corn futures are down 20% from the June 2011 peak.

Packaged goods wholesalers will realize some cost savings from lower commodity costs.

"We've had very, very high inflation across the industry, which led to unusually high levels of price increases, which led to volume elasticities," said Kendall J. Powell, chairman and chief executive of General Mills, during a March earnings call.

"Our strong belief, going forward, is that inflation will moderate and as we see inflation come down, there will be more or less stability in consumer prices and unit volumes will stabilize," he said.

Grocery-store chain Supervalu Inc. (>> SUPERVALU INC.) spokesman Mike Siemienas said the company expects commodity grain costs to remain stable in 2012, translating into stable cereal prices.

Competition may limit earnings growth that results from stable commodity prices in selected food categories, but Kellogg and General Mills will set the tone in the cereals sector.

"In cereals, it's a two-horse game between General Mills and Kellogg," said Jack Russo, consumer goods analyst at Edward Jones in St. Louis.

Competition is limited in cereals. Consumers want branded products, features that limit the competitive forces that encourage packaged food wholesalers to pass along savings from a commodity cost environment that is more favorable, Russo said.

The impact of lower or stable commodity prices should be more apparent in the second half of 2012, with more normalization of commodity prices putting the worst behind the industry.

Wholesalers will have to weigh the risk of reaping the benefits of a better commodity cost environment versus cutting prices to drive new sales.

"Consumers are pretty fickle and picky about what they are spending money on, particularly with private label companies ready to compete on price in the absence of brand power," Russo said.

Large grocery chains such as Supervalu are increasing the presence of private-label brands like Essentials Everyday, Shopping Value and Hyper Local. The increase in competition from private-label brands raises the question: will the large brand-name wholesalers pass along the savings to retailers and consumers.

In 2009, when commodity prices slumped, the market didn't see a big rollback in prices, but this time could be different.

Large retailers such as Wal-Mart Stores Inc. (WMT) and Target Corp. (>> Target Corporation) may push a little stronger for a rollback in prices, as they won't be oblivious to reduced commodity costs in selected food categories, said Russo.

Very competitive frozen, center of the aisle and dry canned goods are more commoditized and will force the large food wholesalers to be more competitive, he added.

The positive cost structure will expand beyond large packaged food processors. Lower grain prices benefit meat processing companies like Tyson Foods (>> Tyson Foods, Inc.), restaurant companies and spirits companies such as Beam Global Spirits (BEAM) that use grains to produce whiskey.

(Andrew Johnson Jr. writes about agricultural commodities for Dow Jones Newswires. He can be reached at 312-750-4126 or by email at andrew.johnsonjr@dowjones.com.)

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