Food companies poised to profit as farmers rebound

Mon Mar 12, 2012 9:22am EDT

Vegetables, including cabbages, leeks, endives and squash are presented in wooden crates at the Paris Farm Show in Paris February 27, 2012. REUTERS/Jacky Naegelen

Vegetables, including cabbages, leeks, endives and squash are presented in wooden crates at the Paris Farm Show in Paris February 27, 2012.

Credit: Reuters/Jacky Naegelen

(Reuters) - The world's farmers are poised for a year of plenty in 2012 after last year's weather-related disasters, and prospects of lower grain prices from bumper harvests could offer relief to the battered bottom lines of grain and food companies.

Food and beverage companies like Sara Lee SLE.N, PepsiCo (PEP.N) and General Mills (GIS.N) have struggled to absorb high costs of meat and grains in the past year, while economic uncertainty has hammered agribusiness giants.

While weather worries persist in some areas -- notably droughts affecting crops in South America and the southern U.S. Plains -- expanded global farm production looks to take the sting out of farm prices for food makers by late 2012.

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Graphic on corn acres: link.reuters.com/dyz86s

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"Let's make the assumption (prices) stay down year over year; that would be a pretty welcome event," said Matt Arnold, a consumer analyst at Edward Jones in St. Louis.

Commodity pricing will be one of the themes when top executives from food, drink and agriculture companies, including Nestle (NESN.VX), General Mills, Beam Inc BEAM.N and Cargill CARG.UL gather at the Reuters Food and Agriculture Summit in Chicago March 12-15.

Makers of breakfast cereal and other packaged foods, such as Kellogg (K.N) and Kraft Foods Inc KFT.N, absorbed some of the recent spike in grain prices and are unlikely to pass along all of their expected cost savings to consumers, Arnold said.

Instead, food makers will probably offer shoppers short-term relief through promotions and coupons, while pocketing some savings to offset the hit they shouldered when grain prices ran up, he said.

The implications of lower grain prices are more of a mixed blessing for meat processors, Arnold said.

Hormel Foods (HRL.N), seller of SPAM and Jennie-O turkeys, would save on feed costs for its turkey-raising operation, but farmers might use those savings to expand their flocks over time, pressuring overall turkey prices.

U.S. beef packers have posted big losses since late last year as the prices they paid for cattle outstripped what they earned on beef, according to private data.

The high cost of cattle has pinched JBS (JBS.N), the world's largest beef processor as well as owner of the largest U.S. cattle feeding operation.

On the restaurant side, regional, semi-national chains such as Sonic Corp (SONC.O) and Jack in the Box (JACK.O) might have the most to gain from food cost relief, since they are not protected by the greater bargaining power enjoyed by names like McDonald's (MCD.N) and KFC parent YUM Brands (YUM.N), said RJ Hottovy, an analyst at Morningstar.

"Corn costs, which play a big part in (influencing) just about all the commodities out there, especially for restaurants, have certainly been a head wind for the past two years," he said. "I think restaurants are looking for any kind of relief as soon as they can."

RECORD WORLD WHEAT CROP, BIGGER CORN HARVEST SEEN

At the U.S. Department of Agriculture's annual outlook conference last month, USDA Chief Economist Joe Glauber said 2011's high prices have prompted a move to greater global production for most farm commodities.

The International Grains Council in its monthly update raised its global wheat production forecast to a record 695 million tons and bumped its global corn production forecast to 864 million tons.

As a result, corn prices are poised to dive 20 percent this year, with food prices expected to rise less dramatically than the previous year, the USDA forecast.

Spot corn futures have already dipped 7 percent from a year ago, while Chicago Board of Trade wheat has plunged about 15 percent year over year.

Prices may actually bump up temporarily as U.S. corn stocks fall to a 16-year low this summer, but big plantings should rebuild stocks and ease food prices later in the year.

Unlike last year, when flooding in the northern U.S. Plains and Western Canada crimped supplies of premium milling wheat and drought thinned Russian wheat stocks, trouble spots for the 2012 harvest look less worrisome, said Bruce Burnett, director of weather and market analysis at the Canadian Wheat Board.

Winter wheat growing areas are larger overall in the Northern Hemisphere than last year, although a cold snap has raised concerns about Ukraine's production, he said.

"There are some dry spots, but there's nothing ripping the marketplace," Burnett said. "If everything goes along like this, certainly there will be some pressure to prices."

GRAIN COMPANIES EYE BIGGER PROFITS

Higher farm production and lower prices form an attractive scenario for agribusiness giants like Archer Daniels Midland (ADM.N), Bunge (BG.N) and Cargill, said Horst Hueniken, a former analyst who is helping launch a global agricultural hedge fund under Hybrid Partners of Toronto.

Cheaper grain prices leave farm companies with more cash flow and theoretically fatter profit margins when crushing oilseeds and turning corn into ethanol, Hueniken said.

Competitive pressures, however, may cause grain companies to reduce prices of products like ethanol, thus passing on cost savings to fuel companies or consumers, he said.

Grain volume is a more important profit driver than price for Western Canada-based grain handler Viterra VT.TO, but the high-production, low-price scenario this year carries some risk, said National Bank Financial analyst Robert Winslow.

If a global glut of wheat drives down prices but harvests in grain-origination areas Canada and Australia are only average, Viterra would likely reap lower profits, he said.

To be sure, grain markets have not yet fully factored in drought damage from Brazil and Argentina, while dryness in the southern U.S. Plains raises concern for wheat and cattle.

And all price bets are off if there is any serious problem with the U.S. corn crop.

"Right now, we are factoring in a decrease in corn prices, but there are a number of variables that could play into that," said Morningstar analyst Hottovy.

"There always is an asterisk."

(Reporting by Rod Nickel in Winnipeg; additional reporting by Bob Burgdorfer in Chicago; editing by Jim Marshall)