Food manufacturing poised for comeback despite inflation

What does it take to run a successful business in the food, beverage and agriculture industry, a sector so dependent on commodities and freight-hauling that the cost volatility of the Covid-19 era might make investors think they sold the proverbial farm? 

The “secret sauce” recipe seems to include patience and a strong stomach—or the wherewithal to pass on higher costs to consumers, who seem more willing to accept price increases as part of a ‘new normal’ in an inflationary environment, said Colin Guheen, a Capital One managing director of investment research for the food & beverage industry. 

Historically, raising prices on grocery and wholesale store shelves by as little as 3% would cause a backlash from consumers, resulting in a big decline in sales, Guheen said. Yet, right now, prices on food consumed at home are up about 13% from this time a year ago, and 23% from 2019, before the pandemic caused bottlenecks in the global supply chain. And while volumes are down about 5% year over year, and less so compared with 2019, they’re showing remarkable resilience, he said.

“Nobody would have ever thought this would happen: You push 23% pricing and people don’t consume a lot less?” said Guheen. “So this environment is quite unique, and it’s showing a lot of so-called health in the consumer.”

Despite this phenomenon, the food industry isn’t one to play the long game, Guheen said, and any experience of negative profit-margin headwind “isn’t a trend they love, they want to know what’s coming next year.”

There may be good news on that front, too, Guheen said.

“We’re slowly going in the right direction on the cost side of things,” Guheen said, as market prices of commodities and oil have fallen roughly 15% since May, bolstering the outlook for food-related businesses despite continued high labor costs and operating disruptions tied to the pandemic.

And while the U.S. economy contracted in the first half of the year due mostly to declining inventory accumulation and slower exports, gross domestic income was higher, providing another reason for optimism, even for companies that weren’t as quick to pass through their costs. 

“We’re showing the inelasticity of demand in this kind of record inflationary environment,” said Paul Baisley, group head of Capital One’s food, beverage and agriculture business.

To be sure, the United States isn’t immune from the impacts of changing global weather patterns that have brought devastating floods and water shortages or the geopolitical conflicts in Ukraine and Russia, which can drastically affect the prices of wheat, corn, natural gas and oil, among other commodities.  

“That’s going to keep everybody on edge, but if you follow the numbers, we’re looking at a higher interest rate environment compared to inflation rate, and we have real rates for the first time in a number of years, so could have a stabilization setup by the middle of next year ” Guheen said.

Food-related companies aren’t quite ready to rejoice, however, as they’re only starting to see signs of improvement in the third quarter, “so it’s still very real for them,” he said.

“But the point is, you’re starting to see some relief—there’s a decelerating trend in inflation,” Guheen said. “So it’s coming down the pike as long as nothing crazy happens.”