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General Mills Inc. (GIS - Analyst Report) has held the government’s three decade old subsidy program for ethanol production responsible for creating shortage in its raw materials supply and, in turn, inflation in corn prices. The retail giant had recently announced that it will raise prices to combat the cost push inflation of corn.

General Mills also predicted that the price hike will hurt earnings in the current quarter and the fiscal year as well. The owner of Cheerios cereal, Progresso soup and Häagen-Dazs ice-cream has also revealed that it had to pay twice as much as last year for wheat and that cost of corn and oats have escalated by 30 to 40 percent. Though General Mills has absorbed much of these increases, it could not help passing some of it to consumers.

The US government had provided subsidies to US ethanol producers since the Carter administration back in the early 1980’s. This gave way to ethanol producer’s dominance over the corn market, diverting almost 40% of American corn supply towards ethanol production as reported by the NY Times. This shrunk corn’s supply for other uses.

According to the Center for Agricultural and Rural Development at Iowa State University, half of the rise in corn prices from 2004 to 2009 was driven by an increase in ethanol production. Increased corn prices and its extension to livestock dependent on corn contributed to the rise in agricultural commodity prices globally.

The ‘ethanol mandate’ under the renewable fuels standard in 2005 was designed to force blenders to mix up to 10% ethanol with petrol to make automotive fuel. The relevance of the subsidy is being questioned as ethanol production is hitting record levels in the US this year with a surplus lying for export.   

General Mills also said that volatility in food markets and shift in consumer dietary habits are pushing up prices in food markets. The company faces stiff competition from Kellogg Company (K - Analyst Report) and Seneca Foods Corp. . It currently holds a Zacks #3 Rank. On a long-term basis, we retain a Neutral rating on the stock, with a short-term Hold rating.

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