The Food Chain by Category One

During the now famous Arab Spring of 2011, global commodities surged to levels where consumers in Asia and other emerging economies were unable to pay for the staples of daily life.  Food riots and civil unrest spread quickly as prices spiraled.

Because many commodities are denominated in US Dollars (its the global reserve currency,) and the US market is able to hedge exposure through the futures markets and government assistance programs, the only economy somewhat sheltered from this ugly run of inflation was the US.

The Treasuries of many emerging economies lack the capital to prevent exchange rates between their currencies and the US Dollar from reaching levels where import prices for crops, gasoline and other materials can no longer be exchanged for a given countries local currency.  In a global marketplace, cross-rates for currencies can be just as disruptive to food supply and inflation as a severe drought or storm damage.

In testimony delivered before a skeptical US Congress, Federal Reserve Board Chairman Bernanke seemed unconcerned that monetary inflation, (caused by the Fed’s quantitative easing,) could have fostered real inflation.  Consumers living outside the US did not share this view.  They understood that while there was supply, the prices for daily food stuffs, (and fuels,) had reached levels that were unsustainable.

US citizens have been conditioned by federal formulas that claim food and gasoline inflation is “transitory” in nature and  not part of what the US calls “core” inflation.  Billions of people across multiple continents do not appreciate this distinction.

As has been noted in previous Food Chain posts, concern is building that inflation will once again emerge in 2012.  There are several reasons for this view, not the least of which is another round of monetization on the part of established economy central banks.  Many believe the process has already begun.

In an effort to keep the Yen “cheap” in relation to other leading global currencies, the Central Bank of Japan has been furiously printing Yen.  Not to be outdone by their main competition in the region, China has recently relaxed reserve requirements for its State controlled banking system.  Concerned that the Eurozone is in its own credit crisis,  the ECB has been pumping Euros into the global system.

What’s most problematic about all this money printing is that central bankers actually understand its inflationary.  They just will never admit it publicly.  It is the dirty little secret of the US credit crisis of 2008 and the ongoing credit crisis in Europe.  Central banks are so fearful that they will be unable to fight another round of global deflation, they are knowingly inflating as quickly as they possibly can.

At the very least, this means 2012 will experience inflationary pressures in commodities similar to what was experienced in 2011.  Already crude oil is at an 8 month high.  Gold bottomed at roughly $1500 in January but has jumped over10% since; this while stocks and bonds have been rallying.

These are disturbing trends.  Futures markets can turn in the blink of an eye.  Prices for food and fuel can move as much as 25% in a month.  The trigger could be geo-political or weather.  However, given the backdrop of central bankers creating inflation, procurement decision makers should not count on current subdued commodities prices.

US farmers are planning to sow the largest corn crop since  WW2.  Record crops are also planned for soybeans and wheat.  Virtually every available acre of US farmland will be utilized.  An additional 7,000 square miles will be planted this year.

There are three factors leading to this historic season.  Global demand from emerging economies; (led by China, Brazil and India.)  Poor weather conditions in 2011, has reduced stockpiles.  And ethanol production in the US means farmers now grow as much corn for gasoline as they do for food and feed.

Global demand for corn, soybeans and wheat has also pushed the value of US farmland to record levels.  While many American homeowners are worried about the value of their homes, prime US farmland now averages $2350/acre.

USDA will soon release its forecast for the 2012-2013 season, but farmers are already signalling they’re not waiting.  Farm equipment makers Deere & Company and Caterpillar are reporting strong demand and earnings.  Same with seed company Monsanto.

Anticipating record US crop production global futures prices have corrected in the past few months, but at current levels the return to the US Agri-business interests could again be double-digits.  2011 saw a 28% gain in net farm income.

The USDA today reported higher inventories of sugar, wheat and corn.  Producers and commodities markets had expected tight inventories, particularly for corn, as pre-reports had warned of bad weather in South America.  The reports were wrong.  In addition to better than expected crop production in the Southern growing regions, USDA is anticipating near record supply in the upcoming growing seasons for Europe and the US, as farmers are anticipating strong demand in 2012 for all key crops.

However, a conflicting food inflation report was also released today by the United Nations.  According to the UN, food prices around the world set a record in 2011; although the upward price bias did decline last month.

Record crops are planned for 2012.  A recession in Europe has been factored into global supply/demand projections for major global food concerns.  But many economists maintain that burgeoning middle-class populations in China, other Asian economies and India, are increasingly willing to spend more of their disposable income on higher quality food items. Most still believe record crop yields will meet strong demand and favorable prices in spite of a one day “sale” for which many investment market speculators paid dearly.

Hostess Brands, makers of iconic brands, Wonder Bread, Twinkies and HoHo’s is said to be near refiling for Chapter 11 bankruptcy protection just two years since it last re-organized.

According to reports in the financial press, the Irving, Texas baker must now re-negotiate over $800 million in debt.  Hostess is struggling to control higher costs for sugar and flour as well as high labor costs.  Unlike other bakers,  Hostess Twinkie and Wonder Bread consumers are unwilling or unable to pay higher costs.  Therefore, Hostess is again facing a cash squeeze.

In addition to the heavy debt burden, Hostess owes another $50 million to vendors, who have grown increasingly concerned about the bakers deteriorating balance sheet.  Hostess will also be forced into another round of  painful labor negotiations with its key unions, The Teamsters, Bakery/Confection, Tobacco and Grain Millers.  (Hostess operates in 49 states with annual sales of  $2.5 billion)

While sales of Hostesse’s core brands have mostly been flat, surprisingly Twinkie sales have been down 2% year-over-year.  Attacking its cost structure as well as its labor, benefit and pension burdens is a tall order for Hostess.  Many companies find it difficult to emerge from bankruptcy a second time.

The Food Chain examines global trends in food production, transportation costs, manufacturing, distribution and finally end-demand.  Ringing in the New Year is always a time to pause and reflect.  Today’s post examines global supply and demand from a different perspective.

First, supply.  You can’t grow crops without land and water.  2011 was a year that saw a loss of land and shifts in global rainfall.   Urbanization continues to take arable farmland out of the global system.  Even more worrisome is that the land being taken from farmers are in countries whose populace is demanding more food and more complex crops.  Livestock also suffers from a reduction in arable land due to the need to grow feed/grains for poultry, pork and beef.

In addition, the other factor impacting global food supply is shifting patterns of rainfall.  2011 was marked by pockets of severe drought in vitally important regions of the US South-East and Deep-South.  The US is not alone in losing crops to weather.    Global supplies for staple crops like corn and wheat were also threatened in other global markets.  (Australia and The Ukraine are examples.)

However, its the shift in global demand that may make 2012 a unique year.  2012 has the potential to test the global supply and demand for crops in a manner American consumers have never seen before.  What if global demand, outside the US, forces prices for wheat, corn, soybeans, poultry, pork and beef so high that American farmers face the dilemma of supplying the American bounty to the US at lower prices at a time when a hungry world will pay more?

2011 may well be remembered for the uprisings in many Mid-East economies.  What caused the populaces in these arid climates to finally rise up and overthrow long entrenched dictators?  Food prices.  Urbanization, drought and global demand could again create an unwanted set of factors that could lead to alarming price increases.  The difference in 2012 could be that crop shortages outside the US could lead to food inflation even with bumper crops in the US.

South Carolina Based BI-LO made a surprise offer to take rival Winn-Dixie private in a transaction that will merge the two Southern grocery chains in a deal valued at $690 million.

Just a few years ago Winn-Dixie was a $30.00 stock with a market capitalization of $1.5 billion.  At the time of the deal, equity shares of Winn-Dixie were trading at just $5.50.  Winn-Dixie has steadily  lost market share to rivals WalMart and Target as the big box retailers have muscled shares and earnings from their supermarket rivals.  Profit margins have always been razor thin in the supermarket business, but WalMart and Target are willing to squeeze already slim margins even further.

Together, BI-LO and Winn-Dixie will present a more formidable partnership as there is very little overlap between the two chains.  Expectations are BI-LO will keep all Winn-Dixie locations opened.

In spite of weak profits, Winn-Dixie was still a company that racked up $7 billion in revenues, had no debt and held $200 million in cash on its balance sheet.

The BI-LO deal immediately set-off speculation that SuperValue could be the next candidate for consolidation.  Super Value is four-times the size of Winn-Dixie, but has also not fared well against stiff competition.

Part of the elasticity of the global Food Chain is a function of the sometimes fickle nature of consumers.  These unexpected shifts in demand can lead to imbalances where supply suddenly has no place to go and leads to quick reductions in price.  However, making long-term decisions based on these short-term price movements is also very dangerous as suppliers are increasingly more sensitive to these trends and move quickly to stem losses.  Global markets are experiencing one of these cycles right now. Europe is either in recession or soon will be. The ongoing credit crisis shows no signs of an easy fix.  Policymakers in Greece, Spain and Italy are proposing significant budget cutbacks.  Since these economies are far more dependent on State sponsored employment and socialized entitlement programs, transferring services from the government to the people will force changes in behavior not seen since WWII.

In the near-term, prices for certain goods and services will be reduced as demand in Europe slows.  But global producers are already reacting.  Container shipments from Asia into European ports are being sharply reduced.  Since the US is more stable and not in crisis, the US market will be the beneficiary of this re-directed volume.  However, suppliers are already taking steps to reduce supply as growth in the US is hardly robust.

In spite of what will be lower costs for certain commodities, goods and products, US procurement officers should use caution extrapolating these near-term reductions into the future.

Every year the the cost of a Thanksgiving Dinner for ten people is calculated with the same parameters. This year the cost is up 13% from $43.47 to $49.20.  The increase is the highest in twenty years.

Led by turkey which is up 20%, peas are up 17%, pumpkin pie mix up 16%, whipping cream up 15%, milk up 13%, stuffing is up 9%.

Factors leading to this increase are the usual culprits, weather and energy costs.  Inclement weather damaged many global crops and the cost of energy which is up nearly 30% impacts all commodities.

In spite of the increase, feeding a family of ten a Thanksgiving meal at $5.00 per person is still a reasonable cost to incur.  Consumers can take some solace in the fact that many of the holiday gifts they intend to purchase will be lower this year.  Food may be higher in cost, but electronics are less costly.

According to reports circulating through global commodities markets, the USDA is set to announce the US corn crop will be the smallest in 3 years.  Corn futures are currently trading at their 52week highs.

Expectations are the US will produce 314 million metric tons, down 27 million tons forecast just three months ago.  In order to put this news into perspective, Food Chain readers need to understand that a supply reduction of 27 million metric tons equals the entire corn production of Argentina, the second biggest corn exporter in the world.

Reduced corn supply, and therefore higher corn prices, will lead to even higher beef, pork and poultry prices.  In addition, corn is also an important component of cheese production.  Just last week, global food giant Kraft mentioned rising prices for its cheese products in its quarterly earnings announcement.

Lastly, ethanol production also claims a significant percentage of the corn crop, putting further pressure on overall pricing.

Absent any additional negative weather events, the market will be fully supplied.  However, this year’s shortfall puts further pressure on the 2012 crop cycle.

In spite of difficult times for the American consumer, their taste for premium coffee continues to grow.

Quarterly earnings news and guidance from the major coffee companies demonstrates Americans are willing to pay more for their favorite coffee drinks.

Led by Starbucks, coffee chains have done something few other retailers have been successful at.  They’ve raised prices, maintained sales growth and delivered healthy profit margins.

Arabica coffee is up from $1.56 to $2.53, but so is demand.  At the same time, demand is slack for lower quality robusta beans.  In addition, many coffee concerns have also announced plans to offer premium coffee products in additional sales channels.