Manufacturers are looking to maintain margins as commodity costs rise

Manufacturers are looking to maintain margins as commodity costs rise

Marcel Smits, chief executive of Sara Lee, took time out from defending the US food group's plan to split in two, to comment on one of the burning issues affecting the food industry - the pressure from rising commodity costs.

"While you're climbing, you tend to focus on a peak in the distance and only to find out that when you get there, there's another peak behind it," Smits said.

On Tuesday (8 February), Sara Lee posted a slump in quarterly profits as input costs hit earnings. The company suffered from the rising prices of coffee, hogs and cattle and Smits - more conventionally - said commodities had become "a major issue" for the business. He insisted, however, that Sara Lee would soon benefit from moves to increase prices and would meet its target for full-year profits.

Unsurprisingly, Smits and Sara Lee were not alone in admitting the effect that raw materials were having on their business. Ralcorp Holdings, PepsiCo and Kraft Foods all acknowledged the impact of commodity costs.

US private-label food group and Post cereals maker Ralcorp said it plans to "accelerate" the rate at which it pushes through price increases to offset soaring commodity costs.

PepsiCo, meanwhile, said it expects its earnings to grow at a slower pace in 2011 than they did in 2010 due in part to more expensive commodities, although the US snacks and beverage giant also cited "difficult" conditions in developed countries and investment in emerging markets.

CFO Hugh Johnston also noted the prospect of growing competition in the beverage sector but what could prove telling were comments from Coca-Cola Co. chairman and CEO Muhtar Kent that his company wanted to build its presence in the dairy sector, where PepsiCo has just made a significant stride with the acquisition of Russia's Wimm-Bill-Dann.

Over at Kraft, the company said its "base business" - that is, excluding Cadbury - had seen its commodity costs rise by $500m in the fourth quarter of 2010, hitting margins. The pressure on Kraft's commodity bill - particularly coffee, meat and cheese - led the company to cut its target for profit growth in 2011.

However, in typical confident fashion, chairman and CEO Irene Rosenfeld insisted Kraft's "very, very strong, iconic brands" and the company's marketing plans would help convince retailers to accept moves to increase prices this year.

And therein lies the rub. Food manufacturers can easily say they will raise prices but will retailers listen? Faced with fragile consumer confidence, retailers will be reluctant to willingly pass through higher costs. A month ago, Sainsbury's boss Justin King warned suppliers that they would have to work "very, very hard" to justify price increases. The latest UN data may show that world food prices surged to a new historic peak in January but manufacturers should not assume their retail customers will wave through price hikes.

The pressure from commodity costs is sure to be a central theme of this week's tranche of results announcements, with Premier Foods plc, Danone and Nestle among the next to issue their latest numbers.

There will, of course, be other interesting topics to discuss, not least Premier's latest disposal - that of its canned grocery business to rival UK business Princes - and whether more will be in the offing. Analysts will be keen to hear whether Danone will make further moves in emerging markets, following last year's acquisition of Russia's Unimilk and the recent speculation linking the French food group to 100% control of Indian baby-food business Dumex.

It is unlikely that Nestle will comment on the speculation that it is one of the nine bidders for half of Yoplait but reports have named the Swiss food giant alongside the likes of General Mills, Lactalis and Lion Capital as having tabled offers for PAI Partners' 50% stake in the global yoghurt business. In the coming days, PAI and fellow Yoplait shareholder Sodiaal, the French dairy co-operative, are to meet to consider the bids. It is shaping up to be one of the food industry's more fascinating recent takeover battles.