Five Food Stocks To Watch As Inflation Rises

foodbank recession, ap, november 2009

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Don’t believe the Federal Reserve when it says inflation is low because prices are indeed rising.Gasoline prices are up 70% over the last three months and overall energy prices have jumped 34%. Food prices have been climbing as well.

If you’re a farmer, that’s great news because the prices you were able to get for your crop rose 36% year-over-year in the fourth quarter. If you’re headed to the grocery store, it’s not so great.

The Federal Reserve will tell you that these rising prices are a sign that “QE2” is working and that deflation fears have been defeated. Janet Yellen, the central banks’s vice chairwoman, said in a Jan. 8 speech that inflation has trended downward. But Fed officials tend to focus on core inflation, which excludes those pesky “volatile” food energy prices.

This exclusion dates back to Richard Nixon who asked his Fed Reserve Chairman Arthur Burns to come up with a new inflation number to hide the real number. This was after the Vietnam War and oil increased 200% and inflation was 8%. Americans didn’t believe the faked numbers then and you shouldn’t buy them now.

Investors need to be aware of these rising prices and make portfolio decisions accordingly. The long side of the inflation trade is energy. If the prices are rising, energy stocks and ETFs will rise. However if food prices are rising, investors will want to avoid grocery stocks and the shares of other food price-sensitive companies. Many of these companies have already stated that they plan to pass on price increases to consumers over the next couple of quarters. Margins are sure to be impacted as well.

Here’s a few names that TheStreet’s Research team has sell ratings on.

Shares of Supervalu Inc. (SVU) closed Wednesday at $7.43, up 4 cents. The stock is down 48% over the past 52 weeks.

This grocery store operator’s sales growth rate is trailing the industry, indicating it’s losing market share. The company recently reported its third-quarter results, posting a year-over-year profit decline of almost 50% and once again lowered guidance.

Supervalu has said it’s going to start passing on rising prices to its customers, and it’s likely this will make it even more difficult to get customers to shop there as opposed to Wal-Mart(WMT), which is able to drive a hard bargain with suppliers because of the volume it purchases.

According to Supervalu, inflation has so far been primarily in the meat, dairy and produce categories, but the company also expects to see dry grocery inflation in low single digits.

Gross margins declined 85 basis points year over year and promotions in carbonated beverages, soups and frozen foods were inefficient. Sales declined 6% in the third quarter. Credit Suisse analyst Edward Kelly thinks that the fundamentals have deteriorated and that the company’s outlook remains extremely challenged. At this point, it seems the biggest positive aspect of the stock is that it’s cheaper than its peers.

Winn-Dixie Stores(WINN) stock is down 12% for the past year. The company is set to report its second-quarter results on Feb. 11, and analysts expect the company to report a loss of 28 cents per share.

That performance would be an improvement over a first-quarter loss of $1.39 per share. The company has been closing stores and recently shuffled around its executive team. Over 3% of the company’s stock has been sold by insiders over the past 6 months with no buyers. According TheStreet Research, Winn-Dixie significantly trails its peers on the basis of its sales and earnings growth rates.

Janney Montgomery Scott analyst Jonathan Feeney lowered his estimates after the company reported its first-quarter miss. He is concerned about the fierce competition in the grocery business, citing Wal-Mart and Publix, which is gaining market share. Feeney writes, “We prefer to stay [on the] sidelines, given its dearth of free cash flow.”

The maths is simple for Dean Foods (DF) — it’s getting more expensive to be in the dairy business and there are fewer milk drinkers.

As the population ages, they drink less milk. Dean Foods, along with its competitors are having a hard time raising prices. Big chains like Wal-Mart are putting pressure on Dean to keep prices down. They use cheap milk as a way to get customers in the doors. So Dean Foods agrees to keep the milk cheap for Wal-Mart — going for volume — hoping to outlast competitors. Unfortunately, no one seems to be leaving the dairy business and if Dean Foods doesn’t agree to Wal-Mart’s demands, another diary company is willing to step in.

Dean Foods also had a plan to cut costs so that the company would be tougher competition for smaller players and force them out, or at least make them give up market share. So far that hasn’t happened.

Overcapacity in the dairy market remains high and the cost savings haven’t been enough. Recently, Dean Foods got its lenders to relax the terms of its covenant requirements but Credit Suisse analyst Robert Moskow still thinks the company is in danger of breaching those new terms as early as the third quarter in 2011. Moskow has an underperform rating on the stock and doesn’t see the milk price war as ending positively for Dean Foods.

Tyson Foods(TSN) may be the largest chicken processor, but it can’t change the direction of grain costs.

Credit Suisse analyst Robert Moskow wrote: “We estimate TSN will face $500m of higher corn and soybean meal prices in fiscal year 2011 which may be $350m when TSN’s favourable grain hedges are taken into account.” He believes Tyson would have to raise prices by 6% to offset the grain price increases. Tyson management says it has a cushion of $200 million to offset grain inflation.

The problem is happening on the beef side of the fence as well. The big question will be whether customers are going to be willing to pay higher prices for beef and chicken. It also hasn’t helped that Russia has essentially banned imports of chicken and pork and it looks like beef will soon join that list. Chicken exports to China are down 57%, cutting that potential customer out of the loop. Moskow isn’t confident that these markets are opening back up anytime soon.

Campbell Soup’s(CPB) management has said that it expects 2-3% inflation, an estimate that includes rising prices for tomatoes following freezing temperatures in Florida.

The company says it can offset this with productivity; although that remains to be seen. What Campbell really needs to rather than raise prices is to increase volume. Soup sells better in winter, so there could be a seasonal lift in volume, but that can’t be counted on as the seasons change.

Credit Suisse’s Moskow thinks the company should focus on its growing beverage and snack businesses and let the soup business go stale. However, the culture of the company will probably prevent this. Admitting that the soup business is declining and focusing on Goldfish crackers is likely a scenario the Campbell Soup folks can’t imagine.

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