Analysis: Wal-Mart's price push tests manufacturers' prowess
NEW YORK/CHICAGO (Reuters) - Consumer staples companies have a problem. It costs more to make everything from soup to soap to soda, but when they raise prices they turn off consumers and strain their relationships with Wal-Mart Stores Inc (WMT.N), their biggest customer.
For some companies, like Clorox Co (CLX.N) and Kraft Foods Inc KFT.N, the problem can be comparatively easy to handle. They either have brands that consumers like, and therefore Wal-Mart needs, or they are big enough to have significant negotiating power.
But Wal-Mart is now pushing its grocery suppliers harder to offer consistently low prices, instead of timed promotions or "rollbacks." That means food companies are unlikely to be able to pass through more price increases and will be forced to pull other levers, such as cost-cuts to protect margins or product innovation to drive sales.
And with many consumer goods stocks trading at a premium to the broader market , analysts say the risk is on the downside. In particular, they see pressure on companies with second- or third-tier brands, such as ConAgra Foods Inc (CAG.N), whose Hunt's ketchup competes with Heinz HNZ.N.
Shares of makers of packaged food that raised prices too much, like General Mills Inc (GIS.N), whose products range from Cheerios cereal to Progresso soups, also may face pressure.
Consumer staples companies that make up two Standard & Poor's indexes -- the S&P 1500 Packaged Foods & Meats Index .15GSPFOOD and the S&P 1500 Household & Personal Products Industry Group Index .15GSPHHPE -- trade at nearly 16 times expected earnings, while companies in the S&P 500 index trade at 12.8 times expected earnings.
"I think we reached the wall in terms of raising price. Consumers can't take any more," said Edward Jones analyst Jack Russo, citing recent Nielsen data showing correlations between price increases and declines in sales volume.
"A lot of these companies are going to have to get back to basics and not raise prices much, and if they want to grow sales they're going to have to do it through innovation, or being razor-sharp on pricing."
For example, General Mills' sales volume fell 11.3 percent in the 12 weeks ended February 18 after the cereal maker raised its average selling price by 11.5 percent with a combination of price hikes and a mix of higher-priced goods, Russo said, citing Nielsen.
One silver lining is that cost pressures are abating, as prices of many commodities, among them corn and wheat, have eased in recent months. Among packaged food stocks, Edward Jones recommends General Mills, Kellogg Co (K.N) and McCormick & Co (MKC.N). It has a "Hold" rating on Hormel Foods (HRL.N), ConAgra, Hershey Co (HSY.N), Campbell Soup (CPB.N) and Kraft Foods Inc.
FROM "ROLLBACKS" TO "EVERY DAY LOW PRICES"
For Walmart, the biggest grocery seller in the United States, lowering prices on a long-term basis can help it convince shoppers that it is the best place to go for everyday items.
With gasoline prices climbing and many shoppers living from paycheck to paycheck, Walmart wants to win a larger share of shoppers' limited spending , after having lost some customers to dollar stores during the last recession.
"We want to work with vendors on that to see if we can take a price lower and leave it there permanently," Wal-Mart Chief Financial Officer Charles Holley told reporters last month. "The price image for a customer is very important."
So far, the switch is working. At Walmart U.S., fourth-quarter grocery costs rose 4 percent, fueled by commodity inflation. As the company absorbed some of that increase and shoppers, for example, opted for pasta instead of more expensive meat, they only paid 0.1 percent to 0.2 percent more for food and household products in the quarter.
Traffic at Walmart U.S. stores rose after six quarters of declines, while sales at established stores have risen for two quarters after nine straight declines.
Still, Wal-Mart said margin declines are likely to persist. Walmart U.S. is cutting $2 billion of costs over two years, trimming spending everywhere from construction to staff scheduling. Greeters on overnight shifts, for example, were moved to roles such as restocking shelves.
Wal-Mart's urge to maintain low prices rather than offer short-term sales puts more pressure on vendors.
"For most categories that Wal-Mart competes in, they are in the driver's seat, they can make or break a manufacturer's year," said Telsey Advisory Group analyst Joseph Feldman.
But some manufacturers such as Kraft, which is Wal-Mart's biggest food supplier, have a leg up. "We started early; therefore we didn't have as big of a sticker shock as some of our competitors," Tony Vernon, president of Kraft North America, told Reuters about raising prices.
In the latest quarter, Kraft's prices rose 7.6 percent on average from a year before, but its sales rose only 6.1 percent, excluding certain items, meaning that consumers either bought fewer items, bought less expensive items, or both.
That 1.5 percentage point hit in the face of such large price increases was smaller than what some other companies are seeing, analysts said.
CUTTING COSTS, LAUNCHING PRODUCTS
For Clorox Co (CLX.N), maintaining a strong relationship with Wal-Mart is crucial as sales to the retailer make up 26 percent of its total revenue. Clorox is among the consumer goods companies with the highest level of exposure to the Bentonville, Arkansas-based chain. (See graphic: link.reuters.com/rub86s)
Wal-Mart is "getting aggressive on pricing" but is willing to eat costs when it wants to, said Clorox Chairman and Chief Executive Don Knauss , pointing to the company's best-selling bleach.
Last August, Clorox raised the price of Clorox bleach by 12 percent in the United States, but Walmart kept the price tag steady.
"Wal-Mart did not reflect that price increase because they see Clorox bleach as a real trip driver," Knauss told Reuters, adding that on some weekends, stores sell out of the product.
Wal-Mart declined to comment on its Clorox pricing.
Meanwhile, several companies are touting new products, such as Procter & Gamble Co's (PG.N) Tide Pods detergent and Campbell Soup's skillet sauces and Campbell's Go! soups in pouches. The hope is that consumers will spend more for these innovations even when they will not accept price hikes on familiar products .
The innovations are not for Wal-Mart alone.
General Mills introduced a smaller Cheerios box for Costco Wholesale Corp (COST.O) that allows for more cereal and less air, said John Church, General Mills senior vice president of supply chain. In addition to getting better shelf space, the new box helps to cut costs, a central theme for Wal-Mart and its suppliers.
P&G unveiled plans in late February to save $10 billion by the end of 2016, by cutting 5,700 jobs, using less-expensive packaging, eliminating duplicate work and altering product designs, among other things.
In addition to introducing dozens of new products, Campbell Soup is cutting costs by 3 percent of net sales per year. One of the ways it has saved is by reducing the cuts of carrots (e.g. diced, chopped, julienned) used in its soups.
As an illustration, Chief Executive Denise Morrison told Reuters that if the company were to go from using 40 different cuts of carrots to only five, it would save money by having to buy and inventory fewer products.
"You're saving on the things that don't really matter," Morrison said.
Companies often try to trim costs in ways that consumers will not notice. From 2007 to 2011, Colgate cut 36 percent of its formulas and 29 percent of the individual items it sells, or SKUs, according to Colgate-Palmolive Co (CL.N) Chief Executive Ian Cook. From 2008 until 2011, it reduced the number of fragrances it uses in various products by 26 percent.
This year, Colgate aims to trim another 5 percent of SKUs and fragrances and 3 percent more formulas, he said.
(Editing by Steve Orlofsky)