Food Makers Hedge Their Bets On Grains As Prices Rise
Friday March 21st, 2008 / 22h55
By Matt Andrejczak Under mounting pressure from surging commodity prices, makers of the name-brand foods that fill the nation's grocery shelves are fighting back on several fronts, deploying an arsenal that includes jacking up prices, shutting down factories, and shedding less profitable brands. But one of the most effective weapons used to defend their bottom line -- and one they rarely discuss in public -- involves placing big bets in the grains market, a strategy known as hedging. Food makers use hedges to protect against sudden price moves, smoothing out some of the peaks and valleys in the commodities market by managing risk through futures and options. This gives them a better idea of what kind of costs they are likely to encounter in the months ahead, crucial to budget planning. If they place their bets well, they can actually turn a profit from futures and options trading. General Mills chalked up $151 million in gains from hedges in the volatile agricultural and energy markets during its quarter ended Feb. 24. This added 27 cents a share to the earnings of the Minneapolis maker of Cheerios, Nature Valley snack bars, and Yoplait yogurt. Part of that gain included $64 million from valuation changes on its grain inventories, according to its 10-Q filing with the Securities and Exchange Commission. The company should be in a strong position to offset future costs. For 2008, General Mills (GIS) has hedged 66% of its costs for key commodities, such as wheat and fuel. "They are smartly locked-in," said Edward Jones analyst Matt Arnold, who rates General Mills shares a buy. "They are as well-hedged as anybody." Food makers are facing unprecedented costs for their ingredients. The U.S. Agriculture Department forecasts average prices for wheat, corn and soybean meal will continue to hover well above their 10-year averages through 2008, bloating their share of corporate budgets. While Kellogg Co. (K) expects to pay more for grains and other commodities this year, the maker of Special K cereal and Pop-Tarts said it has hedged a healthy 70% of its commodity costs for the year. Entering the Hedge Food makers have for decades hedged their exposure to price volatility in the grain market, similar to what the airline industry does with fuel. Southwest Airlines (LUV) is well-known for its success in holding down costs by making the right bets on oil prices, giving it a big advantage over competitors as oil prices hit record-highs. For food companies, the basic strategy calls for entering into long-term forward contracts with big grain suppliers like Cargill or ADM for physical delivery. To protect against price fluctuations, a food company will buy a futures or options contract, said Perry Iverson, managing director of CIH LLC, which advises food companies on hedging techniques. It's become dicer these days to pinpoint the costs of grains and other commodities. Companies are revising commodity-cost projections practically each quarter as they watch contract values for grains surge on exchanges in Chicago, Minneapolis, and Kansas City. For instance, Ralcorp Holdings Inc. (RAH) is planning to fork over more for wheat flour, oats and other ingredients that go into its cereals and snacks. In its 10-Q filing last month, the St. Louis food bumped up its commodity-cost forecast, predicting that costs will accelerate through September "as lower-priced forward contracts and hedge positions expire." Sanderson Farms Inc., a major buyer of soybeans and corn needed to feed its chickens, said 10% of its soybean delivery has already been priced in through the rest of the year. On the other hand, the company said it's fully exposed to market prices for corn, with any market advantage on this front hinging entirely on whatever terms it can negotiate with suppliers. Laurel, Miss.-based Sanderson Farms (SAFM) doesn't stockpile feed-grains, keeping only a week's worth in its mills at a time. "It's just at these values, we just think it would be the wrong time to do a lot of forward pricing," said CEO Joe Sanderson said in a Feb. 26 conference call, citing uncertainty about the amount of corn that's being planted. This is the cautious approach taken by buyers wary of locking in high prices when there's a chance prices in the grain market might move lower. Commodity Headwinds Meanwhile, the rising cost of grain taking a hefty toll. Springdale, Ark.-based Tyson Foods Inc. (TSN) said it expects to spend $500 million more to feed its chickens this year, while rival Pilgrim's Pride Corp. (PPC) plans to pony up an additional $700 million for corn and soybean meal. This is crippling its business. Pilgrim's Pride lost $32.3 million in its most recent quarter, widening a year-ago loss of $8.7 million. Grappling with the bubble in commodities, the chicken producer -- one of the nation's largest grain buyers -- created a new senior-level position last summer. It hired former commodities trader Edwin Carter to manage its risks and exposure in the grains and energy markets. Kraft Foods Inc., the world's second-largest packaged food company, said its commodity costs were $1.25 billion higher in 2007 than 2006. The procurement of dairy products, such as cheese and milk, alone cost the company an additional $750 million. It's hard to hedge against a rise in milk costs, partly due to cold storage limitations. Kraft, based in the Chicago-area, doesn't provide specifics on its hedging activities due to proprietary reasons, according to spokeswoman Lisa Gibbons. In its recent 10-K, Kraft said it doesn't anticipate booking any significant gains or losses for any of its commodity positions this year. It pegged the value of its "net long" commodity wagers at $1 billion as of Dec. 31, about double the value from year-end 2006. Kraft (KFT) said its hedged transactions don't extend beyond the next 19 months. While companies admit they buy commodities futures and options contracts to hedge some of their costs, not all are as forthcoming as to the extent. Hedging programs are tightly guarded. Most companies don't like to discuss them at length, if at all, for fear of betraying their positions to the competition or offering others insights into how they assess market trends. At times, gains or losses on trading hedges will pop up on financial statements. But for the most part, the details are sparse. For this article, spokespersons for Kraft; Sara Lee (SLE); Pilgrim's Pride; Smithfield Foods (SFD); Tyson Foods; and H.J. Heinz (HNZ) all declined to shine more light on their hedges beyond what they've disclosed on conference calls, at investor presentations, or in regulatory filings. "I can tell you that we use sophisticated and flexible hedging strategies to protect our self against volatile commodity conditions...no strategies are executed solely on a directional view of the market," Sara Lee spokesman Mike Cummins said in an email. -Matt Andrejczak; 415-439-6400; AskNewswires@dowjones.com
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