How rising food costs could hurt investors

They may begin to ripple through corporate profits and, ultimately, the stock market. But new short opportunities could open up.

By Stock Traders Daily Oct 11, 2012 4:22PM

Full Shopping Cart in Grocery Store -- Fuse/Getty ImagesThese days, a trip to the grocery store can leave folks feeling like they just stepped out of the boxing ring, their budgets bruised and battered.


It isn't just a figment of one's imagination either -- the numbers prove that buying food has indeed become more costly. The Food and Agricultural Organization's food price index is at its high point of the year, lagging only levels seen in 2008 when surging food costs caused riots across the Middle East and Northern Africa.

 

The causes for the spike in food prices are numerous. The corn belt has suffered the worst drought in more than 50 years, launching corn and soybean prices to record highs. Unfortunately, parts of Russia and other countries in the Black Sea region were going through drought at the same time. These droughts, combined with rising fuel costs and growing populations, particularly in Asia, have created a perfect storm.


But just like pretty much everything else, the stock market has looked past this consumer-pinching problem. Since early June, when food prices really began ticking higher, the SPDR S&P 500 ETF Trust (SPY) is up 13%. With SPY hitting, and being rejected by resistance at the $147 to $148 level, and with a (most likely) weak third-quarter earnings season coming up, the broader market may finally be ready to come back to reality a bit.

 

Beyond this upcoming earnings season, though, these rising food costs could begin to ripple through corporate profit lines, and ultimately, the stock market. The senior economist at FAO recently commented that, "it is highly unlikely we will see a normalization of prices any time soon."

 

So, why does this matter for stocks? Well, because manufacturers and producers will undoubtedly look to pass these increased costs onto customers, who are ill-equipped to handle any price increases. Here is a fact: Since reaching a peak in October 2010, real average weekly earnings have fallen steadily and are now lower by 1.3%. Gas prices have increased by 38% since October 2010, and food prices, according to the FAO's price index, are up 17%. In other words, companies are going to be met with a lot of resistance from consumers.

 

For the broader markets, this is another concern to add to the list. The good news is there is a way to protect, and even profit, from this. One stock to avoid, and maybe even short should it break its $48 support level, is Starbucks (SBUX). Not only will some consumers begin to scale back on their morning coffee runs, and maybe settle for something home-brewed, but the one component in the price index that saw the largest increase in September was dairy (up 7%). Milk and cream, of course, are ingredients in many SBUX drinks and the company will soon be paying more for those ingredients.

 

Another name to avoid or possibly short is Panera Bread (PNRA). The bakery-café chain has already lifted menu prices this year and may need to again, at the risk of driving some traffic away, or watch the higher commodity costs crimp its margins.


It is interesting to look at side-by-side charts of Chipotle Mexican Grill (CMG) and PNRA. Both companies are facing the same issues, but shares of CMG have tanked by some 30% since early June, while PNRA is up 12% during this time. Sure, they have different menus and different business models, but, that is a massive divergence. I’d also point out that PNRA has a rich valuation, trading north of 32 times trailing earnings.

 

If shorting isn’t your forte, there are a couple ways to play the rise in food costs from the long side. Your traditional grocery chain is going to have trouble passing costs on to customers, but cost-leading companies like Wal-Mart (WMT) should benefit. A combination of a more efficient operation, allowing for it to better absorb higher input costs, and the possibility of a bump in traffic as customers migrate from traditional grocers should work in WMT’s favor.


Another idea is to buy agriculture stocks, such as Monsanto (MON). This company provides seeds and herbicides to farmers, helping to increase yield. In a time when farmers have seen crops decimated by the destructive drought, MON’s products should be in high demand come planting season. From a broader perspective, MON and other agricultural companies are poised, in the long run, to enjoy strong demand due to a decreasing amount of farmable land combined with population growth in countries like China and India.


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1Comment
Oct 11, 2012 7:31PM
avatar

And what is our democratic government doing about it?  Nothing!  Groceries are not on the inflation radar, just like many other items!  Time for term limits.  No incumbents!

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