Commodity Costs Taking Toll on Food Makers

For more than a year, food makers and other consumer products companies have passed on much of the burden of rising commodity costs to consumers.

In fact, companies such as H.J. Heinz and Hormel Foods proved again with earnings forecasts and announcements Friday that this was still the case early this year, fueling a rally in food stocks.

But that relief could prove short-lived, as 2008 could be the year consumers say "enough!" and start shunning branded products for less expensive private-label alternatives, industry experts warn.

"The next round of (increases) will actually start to impact consumer behavior in a profound way," Ken Harris, a principal at consulting firm Cannondale Associates, said.

That could hit profits at the companies that already have exhausted most measures to cut costs and become more efficient over the past several years in the wake of soaring prices for wheat, cocoa, milk and energy, just to name a few.

"When you say input costs are going up 6 percent and you are only getting 4 percent net pricing, where do you make up the rest?" asked Gregg Warren, an analyst at Morningstar.

Rising commodity costs and economically stressed consumers are expected to be the key topics when consumer products company executives meet with analysts at the Consumer Analyst Group of New York conference in Florida that begins Tuesday.

For the past several years, many of the big food and consumer products companies have tried to mitigate rising commodity costs by cutting jobs, closing plants and taking other steps to become more efficient.

They also passed some of those costs to consumers in the form of price increases, generally finding little resistance as shoppers continued to eat brand-name foods and use brand-name soap, while cutting back in other areas.

But the pricing power is not unlimited by any means, Cannondale's Harris said. While the current round of price increases that went in place a few weeks ago might not cause a major change, the next will, he said.

Food Stocks: Once Reliable, Now Risky

Concerns about higher costs and weaker pricing power had led to a sharp downturn in stocks that would normally perform well as as defensive plays in an economy that might be on the brink of a recession.

Even after a rally Friday morning, the Standard & Poor's packaged foods index is down 5 percent this year.

The S&P household and personal care index is down 8 percent.

"We think investors remain rightfully focused on US economic weakness and the potential effects around the globe," Bear Stearns said in a research note about the Florida conference.

Consumers have already started trading down in juice and milk, said Brian Morgan, a senior research analyst at Euromonitor International. He also said he expected to see moves down in other staples like bread.

"People will begin to shift away from kind of the newer, higher end things, to higher-volume value brands," Morgan said.

Food price increases are adding to the pile on consumers who are also facing higher costs for gas, rising mortgage payments and falling home values.

The food component of the consumer price index rose 4.9 percent in 2007, according to  Labor Department data.

That was part of the largest overall CPI increase since 1990.

On store shelves, Sara Lee has announced three separate price increases for bread over the past year, Hershey announced a 13 percent increase in the price of about a third of its U.S. candy products at the end of January, and General Mills reduced the size of its cereal boxes last year, effectively raising the price per ounce.

The increases are not just limited to food. Procter & Gamble , the world's largest household and personal care products maker, has taken to summarizing a litany of price increases during its quarterly earnings conference call. The most recent included a 6 percent increase on Iams dog food and an 8 percent increase on Zest and Safeguard soap bars.

Higher Prices, Steady Consumption

What's driving these prices up? How about a 127 percent rise in wheat prices in the past year, as shown by the futures price at the Chicago Board of Trade. Cocoa has been at a 24-year high and is up 45 percent on the ICE futures exchange.

Crude oil is up 65 percent at the New York Mercantile Exchange.

For the most part, consumers have swallowed rising food prices and instead cut back on other items.

"They've cut back as much as they can on a wide range of goods, such as purchases of clothing, how much they drive, or eating out," Richard Curtin, director for the Reuters/University of Michigan Surveys of Consumer said.

But consumers, especially in the lower third of the income spectrum, are more frequently saying that rising costs are hurting their personal finances, which will lead more to resist paying higher prices, Curtin said.

"I think you will get push back," he said.

© 2009 CNBC.com