Costs hit food companies, but stocks still pricey

CHICAGO (Reuters) - Higher costs for corn, milk, labor and other items are weighing on food companies' earnings, and analysts expect to hear more and more about rising costs for a sector that currently trades at a premium to the overall market.

This week, General Mills Inc. (GIS.N) forecast a $250 million rise in commodity and energy costs in fiscal 2008, more than double the $115 million increase for the year ended May 27, 2007. The company forecast an overall increase of 5 percent in input costs when labor is included.

ConAgra Foods Inc. (CAG.N), meanwhile, forecast a 6 percent increase in the cost of goods -- which includes commodities and labor -- for its consumer foods business, its largest segment.

And analysts expect more to come when most food companies report quarterly earnings in the next several weeks.

"We're going to see that across the board with all the food (companies) and in some degree the consumer packaged companies as they report," said Arun Daniel, senior sector analyst, consumer discretionary staples at ING Investment Management.

A sampling of analysts' estimates for 15 U.S. food companies compiled by Reuters Estimates shows five are expected to post lower earnings per share in the second quarter, and one is expected to have flat earnings. Earnings increases at many other companies are expected to be relatively small.

Estimates call for operating income to fall an average of 21 percent in the second quarter and 31 percent in the third quarter for the group, though the average is not weighted and could be exaggerated by large declines at a handful of companies.

Yet food stock prices might not fully reflect the sluggish earnings expectations.

The Standard & Poor's Packaged Foods Index .15GSPFOOD trades at about 19.8 times estimated 2008 earnings, compared with a multiple of 14.2 for the S&P 500 index .SPX.

An analysis of current versus historical data by A.G. Edwards shows that only Kellogg Co. (K.N) is "undervalued."

"We believe this indicates a generally rich valuation for the food stocks these days that is not fully supported by the fundamentals," A.G. Edwards analyst Christopher Growe wrote in a report.

Food companies have been dealing with rising costs for the past four years. A surge in corn prices sparked by demand for the crop in ethanol and increased dairy prices are two of the biggest factors for food companies this year, but other prices are also up.

"This is the fourth consecutive year of significant cost inflation in the food category and actually the year we're facing, we think, is a little more intense than last year," General Mills Chairman and Chief Executive Steve Sanger said in an interview with Reuters. But two or three years ago, it was higher still."

Food companies have dealt with rising costs by a combination of implementing price increases and improving productivity, Sanger said.

For example, General Mills recently increased prices on its cereals and is also reducing the size of its boxes. The later move will bring the price-per box more in line with competitors' smaller boxes and also cut costs for packaging materials and transportation, the company said.