Organic's premium prices may not be high enough: Report

An employee arranges produce for sale at a Whole Foods Market Inc. store in Oakland, California.
David Paul Morris | Bloomberg | Getty Images
An employee arranges produce for sale at a Whole Foods Market Inc. store in Oakland, California.

As it turns out, Whole Foods Market may have a tougher time shedding its "whole paycheck" reputation.

While organics have become more mainstream and commoditized, a new report from BB&T Capital Markets suggests that organic price premiums vs. conventional pricing may still be too low from a producer and supplier standpoint.

"Although organic food products generally command a price premium, it has oftentimes been insufficient to fully offset the higher cost, resulting in narrower margins," said the report. "Consequently, supply has not kept pace. This disconnect has exerted cost pressure on most organic ingredients, which is likely to worsen should demand growth continue to outpace conventional."

The report raises the possibility of higher retail prices down the road for organics and cautions that "could negatively impact demand from more fringe consumers, as well as limit the number of new adopters to organic foods."

"Our thought is some of those middle-of-the-road guys, as they see the premium widen considerably — and if they pay more than three times for shell eggs than conventional — they will be less likely to buy the organic," said Heather Jones, senior equity research analyst in BB&T Capital's Food & Agribusiness Group and one of the authors of the new report.

For organic eggs, there was a 114 percent price premium to conventional at the end of the fourth quarter of 2015 but that premium widened considerably in early 2016 and for the last week of January the number was above 200 percent, or higher than the historical average. The report, which uses data from the U.S. Department of Agriculture, points out that the conventional egg prices soared last year, reflecting national supply issues associated with the avian flu outbreak.

Whole Foods was one of the chains experiencing organic egg shortages in early 2014 due to national demand exceeding supply. The supply crunch for organic eggs appears to have eased for now but the Austin, Texas-based company has other headaches as it scrambles to reverse an earnings slump and get a more affordable image.

"The big thing for Whole Foods on the margin front is more competitors carrying organic and specialty foods and carrying it at a competitive price," said Wedbush Securities analyst Phil Terpolilli, who covers Whole Foods. "They have to sort of reset some of their categories to get more competitive on that side of things."

Whole Foods declined interview requests for this story.

In its report, BB&T Capital looked at organic and conventional pricing for nearly a dozen categories and found a wide range of differences — from organic lettuce trading at just a 20 percent premium to nonorganic and organic beef trading at a 173 percent premium, both through the fourth quarter of 2015.

Much of the organic-to-conventional price gap cited by BB&T Capital was found to have increased in the fourth quarter of 2015 as opposed to the third quarter, indicating that "seasonality of the holiday may be affecting this," said Rafi Mohammed, a Boston-based pricing consultant and author of "The 1% Windfall."

"It may very well be that demand is so high, that there is a temporary disequilibrium resulting in high prices and profits for organic producers," said Mohammed, who argues that it's wrong to take the price premium as merely a sign that something is costly to produce organically. "Over time, new suppliers will enter the field."

Meanwhile, one big issue on the organic livestock side is sourcing organic feed, which can be challenging and costly. The situation has been even tougher in California — the nation's leading dairy state — due to the ongoing drought, which has caused some dairies and cattle ranchers to spend good sums to truck in supplemental organic feed.

"The feed grain shortage has been a notable issue in terms of organic dairy producers not being able to keep up with demand," said Cathy Greene, an agricultural economist and organic foods specialist at USDA. "A lot of them actually grow their own (feed grain) and they are required by law to have a certain amount of pasture in the diet of the animals."

The organic dairy and organic beef sectors experienced supply pressures a few years ago when some producers exited the market because conventional production was paying them essentially the same as organic production. The situation has become more favorable for the organic producers, but there are still challenges ahead.

"The combination of high feed costs, low farm-gate price and, of course, the drought in the West really tightened supply," said Western Organic Dairy Producers Alliance Executive Director Richard Mathews, whose group represents nearly 250 organic dairy farm families. He said the situation back then led to a downsizing of herds and resulted in some farmers exiting the organic dairy market.

Mathews sees new problems ahead under the Trans-Pacific Partnership agreement, the free trade pact between the United States and 11 other countries. He said cheaper imports from organic dairies in New Zealand means domestic organic dairies "will have a tougher time breaking even. I wouldn't be surprised if we see reducing of herds again and more farmers going out of business."