Summer’s Drought Will Wither Lots of Stocks

by Jonathan Berr | July 30, 2012 8:00 am

This summer’s unusually hot weather is to blame for the rise in commodity prices such as corn, which is used to feed dairy cows and chickens. In turn, that’s pushing up prices of milk and dairy products. The U.S. Department of Agriculture[1] recently raised its forecast for cheese prices for 2012 and 2013[2], and it also sees butter prices rising this year. Prices for milk futures are moving up as well[3].

ConAgra Foods (NYSE:CAG[4]). Hershey (NYSE:HSY[5]), Papa John’s International (NASDAQ:PZZA[6]), Kraft (NYSE:KFT[7]) and Dean Foods (NYSE:DF[8]) are among the companies that stand to get hit by rising prices for milk, cheese, butter and eggs — at the same time that the food industry is bracing for a further slowdown in the economy.

So far, many food companies such as ConAgra and Hershey[9] have been able to offset higher commodity costs by raising retail prices. Both recently reported better-than-expected results. The chocolate maker also raised its earnings guidance for the year. However, maintaining that strategy is going to be difficult given the unprecedented challenges farmers are facing because of the weather.

While food companies hedge their exposure to rising commodity prices, as do other major buyers of raw materials, the protection is far from exact given the unpredictability of markets. Indeed, the USDA is predicting[10] that dairy product prices will rise 3.5% to 4.5%[11] next year, along with a 3% to 4% increase in egg prices.

Prices for eggs may double if the U.S. Congress[12] passes an amendment to the Egg Products Inspection Act that would prevent states from enacting what farmers say are “dozens of contradictory and unworkable state laws proscribing farm egg production standards.” The dairy industry issued a similar warning[13] about a proposal in the Farm Bill.

Rising costs may squeeze Dean Foods, the largest milk producer. During the first quarter, Dean saw a 0.4% increase in fresh milk volumes, while the rest of the industry saw a decline of 2.9%.[14] Expectations for the second quarter are low for the Dallas-based company, which will release results[15] on Aug. 8. Revenue is expected to fall 2.4% to $3.22 billion. Per-capita consumption of fluid milk has been on the decline for years as some consumers have come question its health benefits.

Papa John’s and Kraft will likely face questions about rising commodity costs when they report results for their most recent quarter on July 30 and Aug. 2, respectively. Louisville-based Papa John’s is expected to see revenue of $311.07 million in the June quarter, an increase of 6%. Growth in the September quarter is expected to slow to 3.8%.

Expectations are already pretty low for Kraft. Analysts are forecasting that revenue at the New York-based maker of Oreo cookies will rise 1% to $14.04 billion in the June quarter and jump 2% to $13.5 billion in the following period.

High prices for dairy products and eggs may linger for a while. If that happens, food companies will probably try to absorb the increased costs the best they can. The industry may be forced to sacrifice profit margins for market share, which will further depress their stock prices.

Investors are advised to avoid the entire sector for now until the situation with commodities becomes clearer. That is, pray for rain in the heartland.

Jonathan Berr does not own shares of the listed companies. Follow him on Twitter @jdberr.

  1. The U.S. Department of Agriculture:
  2. for 2012 and 2013:
  3. milk futures are moving up as well:
  4. CAG:
  5. HSY:
  6. PZZA:
  7. KFT:
  8. DF:
  9. Hershey:
  10. the USDA is predicting:
  11. 3.5% to 4.5%:
  12. U.S. Congress:
  13. issued a similar warning:
  14. a decline of 2.9%.:
  15. which will release results:

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