Higher grain prices could take a bite out of Spam maker Hormel’s earnings next year.
Although Hormel met analysts’ expectations for the fiscal third quarter with earnings per share of 41 cents, the company noted in its press release that “increased grain costs will present a challenge.”
With the U.S. drought sending corn prices on a tear, analysts expect Hormel to feel the impact in its next fiscal year. (Read More: Drought-Related Food Inflation Will Feel Bad.)
Rising crop prices take a while to work through the system, Timothy Ramey, senior research analyst at D.A. Davidson & Co., said in an interview on CNBC’s “Squawk on the Street.”
“It takes 22 weeks to grow a tom turkey,” he noted. “So the turkeys coming to market now have corn that was purchased quite a while ago, even if there wasn't a hedge. I think we will see margin pressures in fiscal 2013.”
Ramey has an “underperform” rating on the stock and a $25 price target — representing more than 10 percent downside from current levels — given the more uncertain outlook for Hormel’s earnings and profitability next year.
“It is a great company with great management, make no mistake,” Ramey said. “But I think the margin outlook is going to be much tougher.”
Stephens food analyst Fahra Aslam agrees there will be margin pressure, but she is more optimistic on the share price. The analyst rates Hormel “equal weight,” with a $31 price target.
In the near-term, Aslam expects Hormel to benefit from good grain hedges and a liquidation of the hog herd. “Longer term, it will cycle into higher grain prices,” she said and that will have a negative impact on earnings.
She gives management more credit in being able to manage through a challenging environment and continue to innovate. “They're very smart in how they put their marketing dollars to work,” Aslam added, pointing to the fact that Spam helped Hormel grow volumes 4 percent in the fiscal third quarter.
This was impressive, Aslam said, considering “it is very challenging to find growth in the grocery industry.”
—By CNBC.com’s Justin Menza
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Disclosures:
Stephens expects to receive or intends to seek compensation for investment banking services from Hormel in the next three months.