Current market levels not necessarily negative
July 02, 2008
by Morton Sosland
While it’s the rare chief executive of a publicly-listed company in grain-based foods, indeed, in almost any part of the food industry who has neglected blaming an earnings disappointment on high grain and energy prices, the most telling aspect of the current environment is the way that its impacts vary dramatically from company to company. This is by way of saying that there are food processing companies that have benefited from this period of unprecedented market volatility as well as those that have suffered. Because of successful inventory and purchasing programs or due to other strategies that have transformed what for many have been huge problems into powerful advantages, these special companies have managed to produce consistently higher earnings, often in excess of analysts’ expectations.
The lessons that explain these dramatic performance variations are not easy to identify. Sure, some companies have done a superior job of forward coverage of major ingredients, to the point that they have enjoyed lower competitive costs during a time of soaring prices. But favorable hedges always have an end, and some of these enterprising firms have found ways of extending their coverage at favorable levels in comparison to what is faced by their competitors. One need look no further than the airline industry and Southwest Airlines as an example of a company that has produced superior returns because of a carefully conceived hedging program for fuel, while its major competitors have sustained huge losses operating in the same markets.
Still other companies have been nimble in boosting prices to cover fully the sharply higher costs, while at the same time keeping expenses under sufficient control to lessen the burden of soaring commodities. Raising retail prices has never been an easy task in the hotly competitive food marketplace where grain-based foods companies operate. Doing this in the current inflation-sensitive environment is not any easier. Indeed, it may actually be more difficult unless accompanied by product modifications that win the favor of grocers as well as consumers. A few bakers as well as other food manufacturers have succeeded by taking steps built around expanding consumer acceptance of and demand for whole grain foods. If escalating ingredients costs are bad luck for some operators, the presence of the parallel whole grain push is something of a blessing for those companies embracing its advantages.
The urgency of doing well to cope with high ingredient prices is rivaled by the necessity of managing credit and cash resources. High prices might once have been solely equated with higher costs. But in present-day banking and credit markets, higher prices mean massive expansion in borrowings to finance inventories and margins required against futures market positions. Suddenly, this situation has prompted a need for preserving and building equity to meet the demands of bankers no longer willing to extend easy credit. Like lending institutions themselves that have had to raise equity in the wake of the subprime debacle, food companies have had to face up to this need. Fortunate is the company able to raise capital through instruments that do not dilute present holders.
In this presidential election year, it is to be expected that some companies would look to government for help. Ideas range from sensible easing of the conservation reserve to the disastrous suggestion that America should impose export limits. The futures markets, which provide the only effective way of exposing markets to desirable global supply-demand forces, have been particularly questioned in the desperate search for solutions that too often take the political route. Without saying that hardly anything needs doing by Washington to ease a situation that is a national economic problem of rising inflation, a close examination across the breadth of grain-based foods shows that coping is possible. In instances these highly difficult markets have produced great opportunities for improving earnings.