Weak Prices Hit Food Makers, Sellers

(February 9, 2010 - Wall Street Journal)—Deflation is great for consumers looking for bargains. It's not quite as pleasant for the merchants providing those bargains.

Companies in the food business—particularly supermarkets and food distributors—are hoping to see some price appreciation after a year of wrestling its evil twin. Deflation puts sellers on a treadmill, forcing them to sell ever-more products at less price for the same revenue. It also saps profits, as the merchants must continually cut fixed costs, not an easy thing to do.

The impact of persistent deflation will be clearer Thursday as Sara Lee Corp., food processor Bunge Ltd., Kellogg Co. and Burger King Holdings Inc. report earnings. Their view of any moderation in downward pricing and whether consumers have stopped trading down will bear close watching.

Archer Daniels Midland Co. on Tuesday posted lower fiscal second-quarter earnings due to lower selling prices and higher commodity prices, despite increased unit volumes. But it benefited from energy inflation, turning more corn output over to its large ethanol refining operations.

Food distributor Sysco Corp. said Monday its fiscal second-quarter sales were crimped by deflation, mainly in dairy and beef products. Chief Operating Officer Ken Spitler said "deflation pressures appear to be moderating from the highs we saw earlier in the quarter," but have yet to reverse.

Sysco Chief Executive William DeLaney said "we're hoping to see a continuation of the moderation" and at some point "see some mild inflation, but it's hard to call as far as timing."

He's not talking about energy. Oil futures have been bouncing back this week, pressing toward $80 a barrel. Mr. Spitler said he is "very concerned" about rising fuel prices "and how it plays out the rest of the year."

Sugar is another concern. Companies that make and process sweeteners are getting squeezed by rising sugar prices, which hit a 29-year high Monday. ADM and British food processor Tate & Lyle PLC set sweetener contract prices early this year. But with sugar prices spiking, margins are coming under pressure. Tate & Lyle said margins at its U.S. corn-milling operations could fall 10% this year.

Meanwhile, a report on food retail last week from ratings agency Standard & Poor's paints a challenging picture for grocery stores as they navigate the downward pressure on prices. The firm expects sales growth during the next 12 months to bear the weight of continuing deflation "and retailers' willingness to offer low prices to customers in an effort to draw traffic to stores." Competitive pressures "will be intense through 2010," S&P said in its retail report.

"Based on our expectations of rising deflationary food pricing pressures continuing in the first half of 2010, we look for traditional grocery chains on average to experience sluggish comparable-store sales growth for 2010," the report added.

Restaurants aren't expected to have much pricing power either. The U.S. Department of Agriculture last month trimmed its 2010 food inflation estimate to between 2.5% and 3.5%, from between 3% and 4%, mainly because it sees food prices at restaurants rising less than previously forecast.

"In my 30-plus years in retail, I've never witnessed the intense level of price reductions and promotional activity now occurring," Supervalu Inc. Chief Executive Craig Herkert said last month. "My belief is that the recent industry trend toward lower pricing is here to stay."

The Upshot comments on trends in corporate earnings.

Write to Paul Vigna at paul.vigna@dowjones.com and John Shipman at john.shipman@dowjones.com


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