Agricultural Inflation Trims Food Company Earnings

Montreal, Canada

Food inflation is now a major problem – and governments are likely to accelerate recent intervention efforts to protect important crops.

Agricultural price inflation is approaching fresh record highs this month as a host of foodstuffs skyrocket. Most of the food chain is becoming more expensive by the day; the breakfast club now trades near record highs, including sugar, coffee, cocoa and orange juice. Throw in that morning toast and you’ve got some serious price inflation as grain prices rally sharply since last summer.

Mother Nature is definitely a force to be reckoned with in 2010. Similarly to 2008, when a series of weak harvests produced disastrous yields, farmers this year are enjoying a bounty as prices soar. But the sharp increase in ag-inflation is being boosted by inclement and volatile weather across the globe, including the El Nino weather phenomenon, record high temperatures in Russia’s grain-belt last summer and floods in Asia.

The demand equation is even worse, as prices are further squeezed by fast-growing emerging markets.

China now ranks as one of the largest importers of grain – a boon to American farmers. China is now a net importer of rice, corn and soybeans. Other developing economies are rapidly increasing their domestic consumption on the heels of wealth expansion; appetites are more demanding and clamoring for meat, pork and chicken – all of which require animal feed to grow herds.

For investors, scouring the globe for those companies that can successfully pass on rising input costs will be essential to a profitable outcome. Some multinationals, like Nestlé SA of Switzerland, aggressively hedge their input costs while others don’t.

Carlsberg A/S of Denmark, whose primary input costs are Russian barely, reported lower than expected earnings yesterday, slamming the stock 5% lower. Other brewers face the same challenges as wheat prices have gained more than 20% this year while rallying more than 42% over the past 12 months. It’s a similar story for barley.

Increasingly, only the shrewdest food and beverage companies will be able to protect margins. Nestlé probably ranks as the most capable in this strategy.

As food price inflation accelerates and challenges corporate earnings, the industry will have to borrow a page from the airline industry amid record-high jet-fuel prices forcing most carriers to hedge fuel costs. Food price inflation is here.

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