Underlying strength evident in grain-based foods

by Josh Sosland
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By a number of key measures, 2007 was a tough year for grain-based foods. Share price declines were sustained by many prominent industry companies, in large part because of ingredient costs surging to record highs. Going into 2008, no clear signs have emerged that input cost relief is impending.

Despite the seriousness of the ingredient input situation, other developments in 2007 suggested a far more hopeful outlook. Demand trends were the strongest of the decade, the industry appears to have found more secure footing in the age of health and wellness and robust innovation has given the sector renewed energy.

Share prices not setting world ablaze

The industry’s share price performance suggests Wall Street is placing greater emphasis on the commodity headwinds and less on the underlying indications of a recovery in demand. In 2007, the Grain-Based Foods Share Index rose 1%, a sluggish level of appreciation compared with the 12.77% gain in the consumer staples index within the S.&P. 500. The 1% gain lagged gains of 2.4% and 6% in the Food Business News indexes for Meat and Poultry as well as Diversified Foods, respectively. While better than the 5.9% decline in the Confectionery Index and the 6.1% decline in the Produce Index, the Grain-Based Foods Index was far shy of the 26.9% surge in Beverages (non-alcoholic) and the 23.3% jump in Retailers.

When viewed on a company-by-company basis, the performance in 2007 was mixed. Most noteworthy on the downside was the seemingly final collapse in the share price of Interstate Bakeries Corp. (I.B.C.), the nation’s largest wholesale baker of bread and snack cakes. While Kansas City-based I.B.C. shares traded as high as $13 in the year following its September 2004 bankruptcy, the stock declined to $2.40 at the end of 2006. By the end of 2007, investors concluded existing shareholders would receive nothing if the company emerged from bankruptcy, and the stock ended the year trading at 1c per share.

Still, the results at I.B.C. hardly paint a complete picture of the industry. Shares of Flowers Foods, Inc., Thomasville, Ga., another baker of fresh bread, jumped 30%. Other major industry players showed strength as well. While shares of Battle Creek, Mich.-based Kellogg Co. climbed a modest 5% in 2007, the company has been a stellar performer in recent years and financial results remained strong last year. General Mills, Inc., Minneapolis, generated improved results in 2007, helping rebuild the confidence of the investment community. Last week, Credit Suisse raised its fiscal 2008 earnings estimates for General Mills after a company presentation before securities analysts.

The meeting "reinforced our view that the company will outperform in 2008 despite a tough environment with rising commodity costs and slowing growth in consumer spending," said Rob Moskow, an analyst with Credit Suisse.

PepsiCo, Inc., based in Purchase, N.Y., was another standout last year with a 21% share price advance. Its grain-based foods operations include Frito-Lay North America and Quaker Foods.

Ingredient prices surge to all-time highs

While just about every segment of the processed food industry experienced higher ingredient costs last year, the grain-based foods industry was in a class by itself. The advances in ingredient prices have been truly extraordinary, driven principally by surges in wheat and bakery shortening prices. Wheat supplies worldwide have been teetering at precariously low levels for a number of years, and prices surged in 2007 in reaction to crop difficulties in a number of key producing areas worldwide, including the United States.

An index of white pan bread ingredients, calculated by Food Business News, was up 70% in 2007 from the year before, while the pasta ingredient index was up 214%, including a jump of 53% in September alone. Most non-grain-based food ingredients did not rise nearly as much. For instance, the index for vanilla ice cream was up only 9% and pork sausage was up just over 1%.

The higher prices are expected to precipitate a sharp increase in wheat plantings in 2008, but few commodity analysts were projecting a rapid recovery to the world wheat stocks. As a result, considerable price volatility was expected for 2008.

Longer term, the explosive growth of demand for ethanol looms as a continuing drain of acreage away from wheat. Because wheat yields have not grown at the same pace as corn or soybeans over the last decades, and because other crops have been bred to be planted on what historically has been wheat acreage, the outlook for wheat production remains uncertain.

Whole grains as source of growth

Even as these factors appear to militate against the grain-based foods industry in 2008, other data suggest otherwise. Whole wheat flour production in 2006-07 continued its strong rate of growth. At 15.2 million cwts, production was up 21%. Nutritionists have been urging consumers for years to raise consumption of whole grains. This effort reached a new peak with the Dietary Guidelines for Americans 2005, which called for consumption of three or more servings of whole grains per day. While consumption of products made from enriched white flour has been targeted for criticism by certain nutritionists and many purveyors of popular diets such as Atkins, whole grains have few critics.

Whole wheat flour production, tracked annually by Milling & Baking News, rose 10% in 2003-04, and then accelerated 21% in 2004-05 and 26% in 2006-07.

Accounting for the expanded demand has been a combination of increased consumer awareness of whole grains, a veritable explosion of products containing whole grains and the efforts of the Whole Grains Council to help consumers find the products they want.

Standing out among these new products is Sara Lee Soft & Smooth White Bread Made with Whole Grains, a product targeting the large proportion of the population that has eschewed whole wheat bread in the past in favor of the blander flavor and smoother texture of white bread. The bread, baked from a blend of enriched flour and a new generation of finely ground whole wheat flour, rapidly grew to become the nation’s largest selling single stock-keeping unit, spawning a raft of competitive imitations.

But growth of whole grains hardly has been limited to the "made with" products. The Whole Grains Council introduced a special stamp for products made with whole grains, and early last fall, the council indicated 160 companies were members and that the stamp appears on more than 1,200 products.

Flour production: Recovery at hand?

While the growth in whole wheat flour production is impressive, the size of the market remains small. At 15.2 million cwts, whole wheat flour represented only 4.1% of total U.S. flour production in 2006-07.

By all appearances, though, total wheat flour production appeared to be staging a solid recovery in 2007. Flour production in the third quarter of 2007, at 108.6 million cwts, was within a stone’s throw of the record for the quarter of 108.8 million, set in July-September 2000. That flour production could approach record levels seemed highly unlikely only a few years ago.

Through the early 1990s, U.S. flour production rose rapidly to satisfy consumers’ growing demand for a wide range of wheat-based products, including pizza, pasta and bagels. In the late 1990s and earlier in the current decade, growth came to a screeching halt, first because of a slowdown in new products that excited consumers and then because of a surge in low-carbohydrate dieting. Baking, an industry normally characterized by very gradual sales shifts, suddenly experienced precipitous and unprecedented downturns.

In the face of the declining demand and the tidal wave of media attention devoted to questioning whether dietary staples such as bread were fit for consumption, the grain-based foods industry established the Grain Foods Foundation. Since its launch in 2005, the foundation has sought to ensure attacks against flour-based foods do not go unanswered, tapping into knowledge of a scientific advisory team. Additionally, a public relations campaign has been utilized to emphasize the positive qualities of baked foods.

Since the foundation’s launch, demand trends for grain-based foods have turned positive. Driven by a number of factors, including the demise of Atkins-mania, flour production declines ceased within a few months of the foundation’s launch. Flour production now has risen versus the year-earlier period for nine consecutive quarters, the longest such stretch in recent history.

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