Are Food Stocks Safe Havens?

New York-based Moody’s Investors Service thinks commodity prices are likely to rise this year, however. “The costs of some key ingredients — including corn, wheat and soybeans — could moderate further as farmers prepare to increase output to meet strong demand,” says Brian Weddington, vice president and senior analyst for the ratings service. He also pointed out there could be price relief from a softening global economy, which could weaken global demand for some commodities.

Retailers are more receptive to passing on price hikes from suppliers, and consumers have become more conditioned to paying those higher prices, said Weddington.

“While most investment-grade food companies should be able to sustain fairly stable earnings [this] year under moderate commodity inflation, most other companies will have a tough time passing on rising costs, and all are likely to see profit margins contract.” And he added, “If commodity prices rise more sharply than expected, some weaker packaged foods companies that lack sufficient pricing power with customers could come under significant pressure.”

Not every analyst welcomes dramatically lower commodity prices. “We believe the recent, high-profile easing in many commodities may take away from the likely viability of pricing remaining an ongoing part of the growth algorithm in food,” says Andrew Lazar, analyst with Barclays Capital (www.barcap.com), London.

Maintaining brand loyalty is key

In November, Lazar lowered his rating on the packaged food industry to neutral from positive. He cited “muddied visibility” for earnings acceleration in 2009, exacerbated by the fact that consumers are choosing less expensive foods at the supermarket.

“These are all good companies, but you see their weaknesses when costs were high as they were in 2008,” interjects Shanahan. “This year should show improvement, but the issue now is that although costs are down, customer income is also down and many are trading down to private label.

“That could result in a weakening of brand loyalty for all the national brands,” Shanahan continues. “We are going to see marketing campaigns that promote and build brand awareness, reminding consumers that Campbell’s soup and Kraft brands are still around.”

“Supermarkets are investing heavily in their own private-label products. The quality of these products has vastly improved over the past few years,” adds Lynn. “Because the recession is causing the consumer to be increasingly cash-strapped, private label prices, which are up to 40 percent lower, will present a compelling choice in supermarket aisles.”

“There’s gong to be an interesting battle between grocers and food companies in 2009,” predicts Morgan Stanley analyst Mark Wiltamuth, quoted on Forbes.com. “Commodity prices have fallen, so grocers are going to pressure food companies to come down on their pricing, but packaged food companies want to keep prices high. At this point, I think inflation will cool but not disappear. I don’t think we will get into a deflation scenario in 2009.”

Sure, many companies provide generic products to these big retail chains. “However, margins are lower,” says Steven Ralston, senior analyst for consumer staples with Chicago-based Zacks Investment Research (www.zacks.com).

“Wal-Mart’s entrance into the grocery channel has and will lead to even greater consolidation among retailers, shifting purchasing decisions to a few powerful chains and limiting pricing leverage for branded food producers,” Lynn warns.