Food Companies & Grain Costs

Highlights include General Mills Inc. (GIS - Analyst Report), Kellogg Company (K - Analyst Report) and Smithfield Foods Inc. (SFD - Snapshot Report).

Last year, one of the major issues for food companies was the negative impact of rising grain costs, which negatively impacted earnings. Commodity cost increases are usually offset by productivity enhancement programs or by passing the increased costs to consumers through price increases; otherwise, margins are compressed and profitability suffers.

Food companies raised prices to mitigate the impact, but only 50% to 75% of the higher costs could be passed on to the consumer. Food companies had to rely on productivity enhancement and cost control initiatives to make up the difference.

Grain prices -- especially corn prices -- were also driven higher by the growing demand for ethanol as crude oil prices increased in mid-2008. However, crude prices and grain costs fell in late 2008 leading the managements of food companies to expect less cost input inflation in 2009. These expectations are a component of the current earnings estimates.

The recent stock market rally has been accompanied by significant increases in both crude oil and grain prices. Wheat prices have rallied to a one-month high to $5.45 a bushel. Now weather has become crucial to the hard red winter wheat crop, since there is a potential for crop losses from dry weather in the Plains.

It is important to constantly monitor grain costs when analyzing food companies, but especially for companies like General Mills (GIS - Analyst Report), Kellogg's (K - Analyst Report) and Smithfield Foods (SFD - Snapshot Report). If grain and crude oil prices continue to rise, the earnings estimates of these food companies will be lowered.