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Are food stocks good inflation hedge?

By Jenal Mehta

11:09, 29 March 2022

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Is the food industry a good inflation hedge? – Photo: Shutterstock

Inflation has reached historic highs in recent months, but the consumer staples sector is expected to maintain its profitability.

In the current economic climate, not only are the food sectors that directly import from Russia and Ukraine being affected, rising food costs are leaking into other sectors through rising energy costs and supply-chain disruptions.

Historically, food stocks, which fall under the consumer staples sector, have performed relatively well during times of inflation. Due to the nature of the sector, sales demand continues even if prices are increased.

For the near future economists believe these rising costs are likely to be passed on to the consumers. Thus profits for the companies in this sector are likely to be maintained, making them a good inflation hedge.

Why are food costs rising?

The current economic climate has placed pressure on the food chain in many ways. The global supply chain had already been under pressure as global markets recovered from the pandemic, and now there are added supply pressures as a consequence of the Russia-Ukraine war.

Both Ukraine and Russia are suppliers of some key agricultural commodities. Both export wheat, corn, barley and sunflower oil, the majority of which goes to the Middle East, Asia and Europe, according to a report by ING.

Food inflation is also trickling into other areas through rising energy prices. Food manufacturers are seeing higher energy bills, especially in fuel-sensitive sectors such as agriculture and the packaging industry. Furthermore, continued supply-chain bottlenecks are adding to the production bill.

Thijs Geijer, senior sector economist at ING, said: “Exporters will be looking for ways to continue trading, but due to the mounting difficulties, products destined for Russia and Ukraine will be diverted to other markets. This, in turn, can lead to excess supply elsewhere.

“Over time European exporters will likely decrease their exposure to Russia in case of a prolonged conflict and enduring sanctions.”

How is this affecting company profits?

Like any other sector, the winners in the food industry will be the ones that can pass on rising costs to their customers.

Geijer says this is already under way. “ Once their current procurement contracts terminate, companies don’t have many other options than to pay higher prices and try to pass them on to their customers.”

Geijer makes a similar comment on energy-sensitive sectors for the near term, with long-term projections of companies possibly moving away from Russian energy dependency.

“In the short term, food manufacturers will try to pass on higher energy costs. For companies that are relatively dependent on gas, it can be useful to prepare for a scenario in which Russia’s energy supply to Europe is cut off,” he said.

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“The surge in energy prices might eventually make investments in energy efficiency more attractive and stimulate companies to move from gas-powered production processes to other energy sources. This will also depend on whether governments react with more supportive policies and subsidies.”

Although this will come at a cost to the average consumer, companies in this sector are likely to see their bottom line maintained in the coming months.

We are already seeing this trend with the recent results from General Mills (GIS) in the agriculture and food packaging industry, which saw a 10% rise in its net profit margin, according to its earnings release.

Swiss food producer Nestlé (NESN) also saw a rise in income during 2021. Similar growth was seen in Archer Daniels Midland’s (ADM) earnings release.

Distribution giants such as Tesco (TSCOI) and Walmart (WMT) have also shown impressive profitability in the last quarter.

Is consumer staples a good inflation hedge?

Much like the energy sector, the consumer staples sector is a necessity, regardless of the economic climate. The sector can thus maintain sales even if suppliers have to increase their prices.

Research from State Street says: “Conventional wisdom suggests that if prices rise across the entire economy, an equity stake in a company should rise, since firms should be able to pass on higher costs to consumers.

“Sure enough, some sectors, being more affected by inflation than others, can directly transfer any price rises to the end-consumers and are likely to be rewarded with higher profitability in an inflationary environment.”

Its research finds that consumer staples performs well during times of low and medium inflation, but high inflation sees the sector provide negative returns. However, consumer staples performs better during high inflation than the healthcare, real estate and financial sectors, among others.

Meanwhile, research by Hartford Funds places consumer staples in the third spot for equity sectors likely to beat inflation, just behind energy and real estate investment trusts (REITs).

As of now, Mike Wilson, chief investment officer and chief US equity strategist for Morgan Stanley, has this advice for investors: “At the stock level, we continue to recommend investors look for stable cash-flow-generating companies in defensive sectors like utilities, healthcare, REITs and consumer staples.”

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