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10 Food Stocks Hit by Commodity Inflation

Consumer food stocks from Hershey and Kraft Foods to McDonald's and Starbucks say that rising commodity costs are eating into their bottom lines.

Food inflation—from corn and cocoa to sugar and wheat—is an increasingly important global issue and unlikely to go away anytime soon. The United Nation's Food and Agriculture Organization (FAO) said its index of global food prices was at record highs, spiking 25% internationally in 2010, higher even than where the index was in 2007-8 during the last food price inflation crisis.

The quick rise in food inflation started around seven months ago, Nicholas Colas, ConvergEx Group's chief market strategist, told TheStreet recently, building off long-term trends like the growing middle class in China and India where demand for beef and vegetable-based proteins grew disproportionately to demand for grain-based diets. Converting soft commodities like corn and wheat into protein—think cows and poultry—is inefficient, costly and time-consuming.

Rising food prices signal producers should produce more, Colas said, but "you can't just turn a switch." It takes time to plant the corn, it must be the right time of year, and it takes time for the crop to grow.

For food and beverage companies, that means many will have to pass higher costs onto already cash-strapped consumers—and some, like Kellogg, Sara Lee and Panera Bread, already have.

Here then is a rundown of major consumer food stocks, and how rising commodity costs are affecting their performance.

Hershey

Company Profile: Hershey, Penn.-based Hershey is engaged in the manufacturing, marketing, selling and distributing package types of chocolate and confectionery products, food and beverage enhancers and gum and mint refreshment products.

The maker of Reese's, Twizzlers and Kit Kat confections brands said it expects adjusted gross margins to be relatively flat in 2011 year-over-year despite "meaningfully higher input costs."

Cocoa prices surged recently following a one-month ban on exports imposed in the Ivory Coast, the world's biggest cocoa producer, which could tighten world cocoa supplies.

Sugar prices also spiked in recent sessions to three-decade highs after Australia's already flood-stricken Queensland coast was hit with the strongest cyclone the nation had seen in 100 years.

Hershey said that despite higher ingredient costs this year, "productivity and cost savings initiatives are in place" and "we continue to leverage the global go-to-market capabilities we have built over the past few years."

Hershey cautioned its margins would continue to be pressured since passing on all the higher ingredient costs to consumers could hurt its sales.

Kellogg

Company Profile: Battle Creek, Mich.-based Kellogg and its subsidiaries are engaged in the manufacture and marketing of ready-to-eat cereal and convenience foods.

Kellogg forecast that 2011 would be another difficult year in terms of ingredient costs, and expects to experience a 7% increase in grains, sugar and packaging costs.

Kellogg recently raised prices to help offset rising ingredient costs. In its recent earnings report the maker of Corn Flakes cereal, Cheez-It crackers and Famous Amos cookies said it plans to raise prices again in 2011 in a range of 3% to 4%. It also hopes to sell a more favorable mix of higher-priced food items, products which boast wider margins.

Price increases were already implemented on Kellogg brands such as Eggo waffles, Keebler cookies and Pop-Tarts, as well as many of its cereal brands.

Even so, the food processor cautioned this month its margins would remain under pressure as a still-weak economy will lead it to carry some of the higher costs since raising prices could dissuade already-choosy consumers.

CEO John Bryant told Reuters that evidence of price increases boosting the company's sales volume remains to be seen.

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McDonald's

Company Profile: Oak Brook, Ill.-based McDonald's franchises and operates McDonald's restaurants in the food service industry. The company and its franchisees purchase food, packaging, equipment and other goods from numerous independent suppliers.

McDonald's said it anticipates needing to raise prices on some of its offerings this year in order to offset rising ingredient costs, Chief Financial Officer Peter Bensen said on a conference call with analysts following its recent earnings release.

McDonald's anticipated that costs will rise between 2% and 2.5% this year in the U.S. and between 3.5% and 4.5% in Europe. The U.S. Department of agriculture said meat prices could increase by as much as 3.5% this year.

Around 10 commodities make up about 75% of McDonald's ingredient costs, the Golden Arches said in January—Beef, chicken, pork, bread and milk products, paper, cola, ketchup and other sauces, and fruits and vegetables top McDonald's ingredient list.

Benson said McDonald's would "raise prices where it makes sense" but would carry some of the higher costs itself, rather than passing it all on to consumers, many of whom patronize McDonald's for its everyday low-cost food offerings.

McDonald's raised prices in China last year by as much as 1 yuan (15 cents) at more than 1,200 of its restaurants to offset higher commodity costs in the region.

Kraft Foods

Company Profile: Northfield, Ill.-based Kraft Foods, through its subsidiaries, manufactures and markets packaged food products, including snacks, beverages, cheese, convenient meals and various packaged grocery products.

Kraft Foods said higher input costs accounted for 3.1% of its North American business' revenue growth in its third quarter last year, and that rising input costs were offset by favorable pricing and productivity.

In August of last year Kraft raised prices on select products from its Maxwell House and Yuban ground coffee brands by more than 10%. It also raised prices on its instant coffee products.

In December Kraft raised prices again—by about 12%—on its roast and ground coffee products under the Maxwell House and Yuban brands.

In its fourth-quarter earnings report Thursday, Kraft said significant input cost inflation drove its 2011 profit guidance.

"Looking ahead, we expect the operating environment to remain challenging, with significant input cost inflation and persistent consumer weakness in many markets," said CEO Irene Rosenfeld. Kraft forecast organic net revenue growth of at least 5% and operating earnings-per-share growth of 11% to 13% in 2011.

Kraft said higher input costs led its operating income margin to fall 240 basis points year-over-year. Coffee revenue in Kraft's European operations grew in the low-single digits, also driven by higher pricing in response to higher coffee bean prices.

Sara Lee

Company Profile: Downers Grove, Ill.-based Sara Lee is a global manufacturer and marketer of high-quality, brand-name products for consumers throughout the world focused primarily on the meats, bakery, beverage and household products categories.

Higher food costs led Sara Lee to miss fiscal-second quarter earnings expectations. It said commodity costs increased by $127 million last quarter, and by $219 in the first half of its fiscal year, partially offset by $123 million in higher prices during the first two quarters, resulting in a net unfavorable commodity cost impact of $96 million.

The food processor said that higher food costs cut into its results last quarter even as the maker of Jimmy Dean sausages and Ball Park hotdogs raised prices to offset some of that food inflation.

Higher commodity costs more than halved Sara Lee's net cash from operating activities last quarter. Sara Lee said input costs continue to rise in its North American bakery business, and it was preparing for "further price increases in the back half of the year to offset additional cost increases." In its international beverage operations, Sara Lee said it continues to pass higher commodity costs onto consumers.

"While pricing lagged significant commodity cost increases in the first half, the second half will benefit from the pricing actions taken in the first half, along with additional actions planned for the third quarter," Sara Lee said.

Starbucks

Company Profile: Seattle-based Starbucks purchases and roasts whole bean coffees and sells them, along with fresh, brewed coffees, Italian-style espresso beverages, cold blended beverages, a selection of teas and coffee-related accessories.

Starbucks reaffirmed part of its 2011 guidance "despite dramatically higher coffee costs," but revised its earnings-per-share outlook to a range of $1.44 to $1.47, lower than the $1.49 per share analysts had expected.

The coffee shop chain cited higher-than-expected coffee costs, which it said will negatively affect its 2011 EPS by around 20 cents, for the revised earnings guidance, but said it would not raise prices to cover those extra costs.

In September Starbucks had said it may raise prices on its packaged coffee as well as large-sized, labor-intensive drinks to help offset rising coffee and commodity costs.

In December CEO Howard Schultz called the 50% spike in coffee futures "tragic," blaming financial speculators for the run-up in prices.

J.M. Smucker

Company Profile: Orrville, Ohio-based J.M. Smucker is engaged in the manufacturing and marketing of branded food products on a worldwide basis.

In its fiscal-second quarter earnings report in November, Smucker said "escalating commodity costs will continue to present challenges." Its U.S. retail oils and baking segment saw profit decline 10% in the period as costs rose for milk, sugar, and soybean oil.

Green coffee costs were also "significantly higher in the second quarter of 2011," the company said, leading it to raise prices earlier in the year. Smucker raised prices of its Folgers and other well-known brands by around 9%, its largest price hike in years.

Investors will look for an update from Smucker when it reports its third-quarter results on Feb. 17. Smucker said in Nov. it expected "to recognize steadily higher green coffee costs during the remainder of the year," and said "higher costs were also realized for milk, sugar, and soybean oil while lower costs were recognized for peanuts and flour."

On Feb. 8 Smucker said it raised retail prices for most of its coffee products—particularly those under the Folgers and Dunkin' Donuts brands—by about 10%, following the two price increases in 2010, as unroasted bean prices continued to rise.

PepsiCo

Company Profile: Purchase, N.Y.-based PepsiCo is a global food, snack and beverage company, which manufactures or uses contract manufacturers, markets and sells a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods.

The maker of Mountain Dew soda, Tostitos chips, Tropicana orange juice and Quaker oatmeal said rising food costs pressured its bottom line last quarter though PepsiCo did beat profit expectations when adjusted for one-time items.

Performance in Europe last quarter was adversely impacted by higher costs related to potato crop shortages in Russia, PepsiCo said.

PepsiCo cut its 2011 earnings growth guidance to a range of 7% to 8%, down from its prior outlook for growth of 11% to 12%, citing "challenging commodity cost inflation and a difficult macroeconomic outlook."

CEO Indra Nooyi said "high levels of commodity cost inflation" will weigh on PepsiCo's results this year.

CFO Hugh F. Johnston said he expects PepsiCo's commodity costs to rise between 8% and 9.5% in 2011.

Panera Bread

Company Profile: Richmond Heights, Mo.-based Panera Bread and its subsidiaries operate a retail bakery-cafe business and franchising business under the concept names Panera Bread, Saint Louis Bread Co., and Paradise Bakery & Cafe.

Panera posted better-than-expected quarterly earnings as its profit and revenue surged, but chairman Ronald M. Shaich said the company was not immune to commodity cost increases.

Shaich told TheStreet Panera instated some modest price increases throughout the recent recession to cover rising input costs. Last year the bakery-café restaurateur hiked prices on certain menu items by 2%.

Panera projected a year-over-year price increase of approximately 2% again in 2011, while maintaining stable margins.

Shaich said Panera experienced higher costs in dairy and wheat, as well as significantly higher costs in coffee.

He said Panera has historically been able to pass on underlying inflation costs to consumers. Food makes up about a third of the company's overall costs, he added, and "we'll continue to adjust our pricing to reflect our underlying costs."

Chipotle Mexican Grill

Company Profile: Denver-based Chipotle Mexican Grill develops and operates fast-casual, fresh Mexican food restaurants in 35 states throughout the United States, the District of Columbia and Ontario, Canada.

Chipotle beat quarterly profit expectations but said higher food costs worked to partially offset Chipotle's strong 12.6% gains in comparable same-store sales last quarter. (Same-store sales figures refer to sales at stores open at least one year and are a closely watched metric in the restaurant industry.)

Food, beverage and packing costs jumped 28.4% year-over-year to $149.6 million in Chipotle's recent quarter, making up 31% of total costs, compared with a 30.1% share in the year-earlier period. Much of the higher costs came from beef, cheese and avocado costs.

"We expect continued inflationary pressure on many of our ingredients, especially chicken, beef and avocados, during the year," said Chipotle CFO Jack Hartung on a conference call with analysts. He forecast food cost inflation in the mid-single digits for 2011.

Cold weather in Florida and Mexico could pressure key ingredients like tomatoes, green peppers and tomatillos.

"The cost of these items has surged threefold as a result of severe crop loss, which, if we remain fully supplied, would increase our food cost by over 200 basis points," Hartung said.

Despite the anticipation of higher costs, Hartung said Chipotle would hold off on passing those prices onto its customers "which will allow us to see how inflation plays out on a sustained basis and allow us to see how consumers react to price increases from other restaurants and grocers."