Janney Capital discusses the impact of grain and livestock prices on shares of PepsiCo, Hershey's, Hormel, and others.
Janney Capital Markets
THE MACRO OUTLOOK WAS mixed last week, with improved U.S. data (e.g., GDP, personal income/spending, initial jobless claims, consumer confidence) offset by the EU's sovereign debt crisis, Korean geopolitical tensions, China's monetary tightening, and weak U.S. home sales.
Food inputs rose as a result of steady Chinese demand and supply concerns due to La Nina, yet the dollar's strength (up 2.4% week-over- week) clouds the outlook.
The USDA maintained its Food consumer price index (CPI) targets for calendar-year 2010 (CY2010) (1-to-2%), with lower egg prices offsetting an increase in pork, and calendar-year 2011 (CY2011) (2-to-3%), despite higher inflation in fats and oils, and sugar and sweets.
The agency expects inflation to accelerate in fourth-quarter 2010 (4Q10) and the first-half of 2011 (1H11).
We expect this commodity push to provide near-term relief for retailers' margins and manufacturers' top lines and to restore historical competitive dynamics, advantaging cereal maker Ralcorp (ticker: RAH) rated at Buy) and snack-maker ( PepsiCo (PEP) (rated at Buy)) and disadvantaging meats and dairy makers Kraft (KFT) (rated at Neutral), and Dean Foods (DF) (rated at Neutral)).
Grain prices were boosted by La Nina and China: Corn (3.4% week-over-week (w/w), soybeans (3.1%), and wheat (SRW 0.6%, HRW 1.6%) all rose due to sustained Chinese demand (soybeans, corn) and increased crop concerns. China's soybean imports may rise 38% year-over-year (y/y) in fourth-quarter (Q4), despite its vigorous efforts to dampen commodity prices.
As a result of La Nina, dryness in South America (soybeans, corn) and the U.S. Midwest (wheat, corn) and wet weather in Australia (wheat) led the International Grains Council (IGC) hence to cut its corn output forecast by 0.5% despite rising supplies in Argentina and Ukraine.
While grain users are facing the most inflation next year, we expect the impact to be a net positive for the cereal category, as it should end the competitive intensity enabled by deflation and should be substantially offset by cost savings for Kellogg (K) (rated at Neutral) and General Mills (GIS) (rated at Neutral).
Proteins are slightly up as solid demand offsets looser inventories. Hogs prices rose 1.8% week-over-week, with cattle up 0.8% and chicken about flat, as strong holiday demand (beef packers increased 5.1% year-over-year ) and concerns that cold U.S. weather could restrict animal weights more than offset looser U.S. stockpiles (pork was down 7% year-over-year in October versus up 20% in September, beef was down 6% versus down 8%, and poultry was flat versus down 5%)and geopolitical tensions in Korea (South Korea is the fifth largest U.S. beef/veal buyer, and sixth largest for pork).
The USDA raised its pork CPI forecast by 50 basis points to 5%-to-6% this year as hog prices rose last month, while U.S. beef exports should remain strong as Australia's cattle prices stand at the highest in over four years.
Pork exports, however, continue to look soft, which could weigh on the cutout margin. Still, this margin remains well-above a year ago and continues to bolster Hormel's (HRL) (rated at Neutral) profits despite risks to its value-added margins, though its volume performance was laudable last quarter.
Natural gas surged 5.6% week-over-week as domestic inventories were tighter than expected (down six billion cubic feet (bcf) week-over-week versus flat consensus) and East Coast weather is expected to be colder than previously forecast.
Crude oil increased 2.9% week-over-week as an improved U.S. macro outlook outweighed the stronger dollar. Crude oil inventories unexpectedly expanded in the week ended Nov. 19 (up one million blue barrels versus a consensus of down two million) as imports rose 15% week-over-week.
Distillate stockpiles decreased by 0.5 million blue barrels, while motor gasoline stocks increased by 1.9 million with demand flat year-over-year.
U.S. sugar and cocoa soft, while world sugar pops. World sugar jumped 8.0% last week as concern mounted that lower output in Brazil, India, Australia, and Russia could result in an unexpected deficit next year.
U.S. sugar, however, declined by 0.7% week-over-week, and cocoa (declined by 2.5%) remained soft as rising exports in Nigeria (up 38% year-over-year, and the third largest producer in Africa) and Cameroon (up 18%, and fourth-largest more than offset geopolitical volatility in the Ivory Coast.
Hershey's (HSY) (rated at Neutral) fading price tailwind should lead to more normalized growth next year. Despite its 20% price-to-earnings (P/E) premium, the company's restored ad spend and strong cash flow should limit the downside.
--Jonathan Feeney
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