Smaller food shops could become commonplace as the Ukraine crisis risks inflating elevated costs for consumers in developed markets worldwide.
It’s potentially bad news for food manufacturers and retailers alike in an inflationary environment that’s already lasted months but, so far, suppliers have been successful in pushing through price increases. However, inflation pressures are now intensifying with Vladimir Putin’s invasion of Ukraine.
Prices of food commodity, energy and transport costs were already going up due to a mismatch between supply and re-emerging demand as the world and businesses started to wake up from the worst of the Covid-19 pandemic.
Sanctions on Russia, and with Ukraine essentially cut off from export markets for its wheat, sunflower oil and barley, have spurred a renewed surge in oil and grain prices, prompting some analysts to adjust food inflation forecasts and predict longer-term pain for consumers than first envisaged.
‘Trading down’ is a common practice employed by consumers when purse strings tighten, whether from branded products into private label, from fresh and chilled foods into ambient and frozen, from beef and lamb into pork and chicken, or curtailing purchases of premium, organic or plant-based. Or a subtle shift from major retailers and health food shops into discounters and dollar stores.
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Nonetheless, while shopping habits during an inflation cycle tend to differ between affluent and low-income families, analysts still aren’t seeing any significant evidence of trading down. Some argue pent-up savings from the lockdowns and government stimulus have provided a buffer, with food manufacturers still able to push through multiple price increases to the retailer, and consumers having to stomach it.
From a UK perspective, Clive Black, a director of investment group Shore Capital, outlines a scenario playing out related to “pandemic normalisation” versus an increasingly inflationary environment.
“We’ve seen evidence of rising inflation in food [but] we’re not seeing any underlying volume or mix shifts at the moment. The biggest factor is pandemic normalisation, leading to increased food-to-go, baskets over trolleys and easing of online demand, but we’re not actually seeing category or temperature shifts yet,” he explains.
“But if we’re correct in expecting inflation to be higher for longer, there will be indications that volumes will ease first of all and then, eventually, evidence of trading down.”
Savings buffer
With Brent crude oil prices flirting with a record high this week and wheat reaching levels not seen in 14 years, consumers may soon have to start making trade-offs.
The UK’s official measure of annualised inflation climbed to 5.5% in January, the highest level since 1992, with food and drink prices up 3.9% and 4.4% over a two-year horizon.
Inflation was even faster in the US, rising to an annual rate of 7.9% in February, the most since 1982, with food prices also up 7.9%, from 7% in January.
Before Russia invaded Ukraine on 24 February, Shore Capital predicted food inflation of 3.5% to 4.5% in the UK for the whole year, peaking around 5-6% in the spring. It could now reach high single-digits, even double-digits given the uncertainty over the potential duration of the conflict, and “it’s going to last for longer” rather than easing off late in 2022, Black says. “Food inflation is now going into more unmanageable territory rather than manageable”.
However, Shore Capital estimates there is GBP175bn (US$230.6bn) sitting in UK personal bank accounts amid a pandemic-related savings ratio of 8% among white-collar workers, while house prices are still going up and there’s “full employment”.
“That’s why we have challenged the term until recently, or until this week – the cost-of-living crisis – because inflation has been 5.5% and wages are going up 4.5%. That is a squeeze of living standards but it’s not a crisis,” Black asserts.
“If middle-income families are saying we’re going to trade down in our weekly grocery shop – not impossible – but I think there are things (big-ticket items) that will be given up before we get to that point.
“The lower-third of the market is where we would see the biggest shifts out of chilled into frozen, out of beef and lamb into pork and chicken. Ambient will probably generate a boost as well out of premium, which will be the movement the retailers will be most worried about trying to prevent.”
Cost pressures continue for suppliers
Food manufacturers’ earnings and revenue statements in recent months have been dominated by lengthy commentaries around input-cost inflation and supply-chain bottlenecks, largely because of Covid, replete with dire expectations for future levels of inflation.
While they have employed revenue growth management techniques such as improving productivity, and in some cases so-called price-pack architecture – shrinkflation – a run of price increases has been a common countermeasure.
2 Sisters Food Group, the largest poultry processor in the UK, this week warned of the prospect of inflation not seen in 50 years, with CEO Ronald Kers flagging the possibility of the country seeing 15% food inflation by mid-year on the back of rising commodity prices linked to the Ukraine crisis.
Danone, the France-based dairy giant, anticipates low- to mid-teens inflation for 2022, posing a risk to a loss in volumes and gross margin depletion. Nevertheless, the Alpro and Activia brand owner has so far proved resilient to any private-label trade-off.
Speaking at this week’s capital markets day event, Danone’s CEO for North America, Shane Grant, claimed the resilience stemmed from catering to consumers’ pandemic-related needs on immunity, gut health, low-sugar and high-protein.
“We really have not seen private label emerge as a driver in any kind of down-trade way. In fact, we’ve seen up-trading based on injecting more meaning into the brands,” Grant said.
Meanwhile, US-based breakfast cereal maker Kellogg and snacks-to-soups to baby-food producer Hain Celestial have all warned of double-digit inflationary pressures this year. Hain Celestial, which adjusted its outlook in February to 10% from 5-6% before the conflict in Ukraine, said its energy costs in Europe were ten times those of last year.
John Baumgartner, a US-based managing director at Japanese investment firm Mizuho Securities, says there’s been “very little elasticity” – a measure of the demand dynamics from rising prices – although he adds: “I imagine that’s not going to last forever, especially with gas prices coming up.”
However, a similar scenario to the UK appears to be playing out in the US in terms of savings.
“There’s this mixed debate in the US. We’ve had all this wealth accumulation over the past two years, savings rates are up, there’s money to be spent. Then other folks are saying of that savings pool, a lot of it is concentrated in income groups that don’t really spend a lot of money anyway,” Baumgartner explains, noting the landscape might be different this time around.
“I’ve seen over the past 20 years, you kind of go into these cycles of economic weakness, weak income growth, high food cost inflation and it feels like almost every cycle was a bit different.
“Sometimes you’ll see consumers continue to buy meat and dairy and shop out further in the store at the expense of packaged goods in the middle of the store. There are other times where we’ll kind of cut back on the protein and the dairy and the produce, and they’ll save that money and buy more of the cereal and packaged goods.”
Where might the pain point for consumers be?
With respect to a potential trade-off into own label in the US, Baumgartner says the market is small compared to Europe, where it’s “twice as high” from about an 18-19% share Stateside. And he asserts consumers in the US have become accustomed to eating at home while seeking out healthy options such as protein shakes and foods low in carbs and sugar.
He poses a rhetorical question: “Is there something else in your mental equation now before you stop buying those products? Maybe instead of going out to eat, spending $30 or $40 in a restaurant, you won’t go out to eat on that Friday night, and you’ll save that money to continue to buy some of these healthier food products that are a bit more expensive.
“Nobody really knows how that’s going to play out, where the pain point is for a lot of these folks.”
Alexia Howard, a US-based senior food analyst at asset-management firm AllianceBernstein, argues manufacturers have the advantage nowadays of machine-learning tools to gauge the optimum price points consumers can endure, although she concedes the elasticity story is likely to intensify.
Other than revenue growth management tools, food makers have few options – “It’s hard to really pivot on innovation super rapidly,” she says, while playing around with ingredients is a risky strategy.
“We haven’t really heard much about changing the nature of the ingredients as yet. I don’t know that any company would really want to be paddling in the direction of ‘we’re going to reduce quality to hit the margin numbers’, because that typically ends in tears at some point,” Howard says.
“The other thing that’s changed is real, meaningful improvements in digital capabilities and big data and artificial intelligence and machine learning. I do think that the companies have got a bit more sophisticated over the last two or three years in terms of really analysing down to almost the store level – what pricing is optimal relative to what other companies are doing or other brands are doing, relative to what the retailer is doing with private label.”
Some suppliers face margin pressure
Kick-back from retailers against continued price increases from the manufacturer might be a distinct possibility but Baumgartner argues they are facing the same pressures from labour and transport costs, and logistics and supply chain outages, which are pushing up operating costs.
“If you’re going to push back on food companies and say you can’t raise prices, they’re going to respond by cutting advertising, cutting trade promotion dollars, cutting new products, and you’re going to starve the store of growth,” he says.
“You’re probably better off allowing the full degree of inflation to come through and leaving it up to the consumer.”
Inevitably, however, Howard believes there will be an uplift in private-label sales among low-income households seeking to save money in the grocery store to spend on family activities but at the same time leaving the door open to indulgence in snacks and treats, whether own label or branded.
There could be a trade down from more expensive stores like Whole Foods Market, Wegmans and Sprouts to the benefit of “mainstream” grocery outlets like Walmart, she says.
“If we see a further trade down to dollar stores at some point, which is possible, and the mainstream grocery channel comes under pressure as reopening builds momentum, then you could start to see a pretty difficult situation developing where the retailers are fighting with each other to preserve shoppers,” Howard argues.
“That means more competition on the basis of price and promotional activity – and that coming right in the middle of the biggest round of commodity and freight and supply chain pressures that we’ve ever seen, or certainly in my lifetime, 15-16 years covering the space.
“That could get pretty difficult for suppliers or manufacturers that don’t have pricing power because the retailers will probably ask for more price concessions or stepped-up promotional activity to retain the shelf space.”
As inflation accelerates and the cost of living continues to rise, and retailers fight to retain business, some of the price increases could be wound back. That would put added pressure on manufacturers’ margins, some of which have already lost “several 100 basis points” on the gross line, Howard attests. “It could get worse before it gets better.”
Meanwhile, Pascal Boll, an analyst at US investment bank Stifel covering listed European food companies, says the gap between private label and branded in the US has been narrowing as we come out of Covid and the impact of inflation becomes more pronounced.
However, he suggests “it’s a very ambiguous environment”.
Boll explains: “What you should bear in mind is that during the pandemic, some supply chain issues for private-label food also resulted in branded food outperforming private label.
“And now, with tighter supply chains again, it seems that at some point, for some categories, this could repeat itself. It’s not only the demand which could see a down trade, but also it’s a topic of availability from the supply side.”
A drawn-out crisis in Ukraine, now entering a third week, will surely put further pressure on stretched supply chains – from food commodities and ingredients, to packaging and aluminium used in canning and other applications, to oil and gas, to name a select few. And that will come at a price for consumers, unless, as Black suggests, governments step in with stimulus and consumer support measures.
Ultimately, Black says: “If the world is serious about beating Putin or not allowing Putin to win, then we’re all going to pay for it.”
