COLUMN-Grocery giants bloodied by surge in corn prices: Maguire

By Gavin Maguire

CHICAGO, July 27 (Reuters) - It's not just cattle feeders and ethanol manufacturers who are feeling the pain from the recent sharp rise in crop prices. Top manufacturers of goods that line grocery store shelves and meat counters have also been reeling of late as their share prices slump on the back of the dramatic surge in key production inputs.

Pork giant Smithfield Foods, chicken producer Tyson Foods and breakfast food maker Kellogg Co have all suffered steep share price declines lately on worries that each firm will have trouble passing on the steeply higher input and ingredient costs to consumers amid the prevailing uncertain economy. But the alternative to raising prices is to reduce production, so corn bulls need to be on the lookout for demand erosion in corn among grocery store giants as well as at the more closely followed cattle feed yards and ethanol mills.

SHARE PRICE SORROWS

Getting accustomed to corn's recent rally - up more than 50 percent in six weeks - has proven to be tough for all corn market participants, but has been especially hard for large end-users of the commodity who have had to simultaneously manage a swoon in share price value as well.

As the graphic below shows, the share prices of Smithfield, Tyson and Kellogg's all turned lower in recent weeks just as corn prices took off to the upside on the back of fears that a drought across the Midwest will greatly reduce 2012 corn production. Soymeal prices followed a similar path to corn as the soybean crop also suffered in the heat, to further exacerbate input-price headaches for large feed and food ingredient buyers.

An interesting component to this crop price/share price relationship is that it is likely the steep elevation in deferred corn and soymeal prices - rather than the rally in spot prices - that caused most of the damage to meat and cereal producer equity markets, as those higher forward prices effectively wiped out good portions of next year's profit margins for the companies concerned. Furthermore, while most top-tier food processors actively hedge input requirements for the coming three to six months, few have the wherewithal to actively defend themselves against the kind of run-up seen in crop prices that are still more than 12 months out.

The end result has been a steep retreat in the share price of - and investor demand for - companies that are heavily reliant on the purchase of volatile commodities such as corn and soymeal while vying for price-sensitive consumer dollars in highly competitive grocery store aisles.

And given expectations that the current spate of drought-driven crop market jitters may persist until the end of the year, it is possible that the recent challenging spell of food processor volatility could last for the foreseeable future as well.

'HIGH' PRICES NOT NECESSARILY THE PROBLEM

While it is clear that cost-sensitive crop buyers such as food processors are faring badly in the current environment of surging corn and soy prices, it is not the actual level but the volatility of those prices that is doing the damage.

Input inflation has been a well-established fact of life for these firms for as long as they've been in existence, and each company has had to find its own way of accommodating and passing on those higher costs.

In many ways consumers are also used to rising food prices at the grocery store, even when they are disguised by smaller packaging sizes and reduced portions as is often the case with breakfast cereals, deli products and juices which tend to occupy the same shelf space as competing brands.

And even during times of economic hardship, consumers rarely change their grocery purchasing behavior too dramatically, even if they do cut back on going out to eat.

That said, while gradual increases in costs can often be passed on to consumers over time by the manufacturers or retailers, sudden and enduring price changes are far more difficult to accommodate given the immediate impact those higher costs have on producer and retailer profit margins, and the likelihood that consumers will be scared off by any sudden price rise of any product that has well-established substitutes on the shelf next to it.

This is the situation facing many large food producers currently, as they are still coming to terms with the 50 percent jump in corn and 30 percent jump in soymeal prices since the middle of June.

And again, it is not only spot prices of those commodities that have risen aggressively, as December 2013 corn prices are also more than 20 percent higher than as of mid-June, even though that crop is still roughly 10 months from being planted and more than a year away from being harvested.

An additional worry facing food producers and retailers is the influence of corn prices on the cost of grocery cart staples. Routinely purchased items such as flour, potatoes, margarine and sugar have all broadly followed corn's path higher in recent years due to corn's presence in the manufacture of those products or corn's potential pull on the acreage dedicated to growing those items.

And as can be seen in the graphic below, corn's sharp run higher in 2008 preceded similar advances in many other commodities, raising the prospect of another round of price gains across the board in 2012/13 in the wake of the latest corn market explosion.

The good news for food producers is that their competitors will all be in the same boat. But the bad news is that in the current weak economy any such broad-based rise in food staples will likely slow any demand growth being seen in grocery store sales, and place even greater pressure on food makers to keep costs in check and prices low.