Inflation may become a bigger worry in 2011 for food companies

Inflation may become a bigger worry in 2011 for food companies

On Thursday, government data showed food inflation building up to 14.2% between April and December, compared with the year-ago period. One could say it is lower than the 21% build-up in the year-ago period. But that will not make a difference to the average consumer, whose shopping basket becomes more expensive every year. Earlier this year, the government seemed confident that prices would cool down around this time, based on the high base effect and predictions of a good monsoon. While the price trend in goods such as wheat, rice and milk indeed appears to have turned benign, the rising prices of others such as meat products and vegetables have kept up the pressure on inflation.

Consumer companies would be stumped at this continuing run of rising prices. The industry expected inflation to moderate in September, but that did not happen, taking it by surprise. The continuing high food inflation will be a disappointment.

Also See Weight of Prices (PDF)

Food companies get affected by inflation in two major ways. One, since inflation eats into disposable incomes, consumers seek ways of managing the household budget on the same income. They will still consume, but in lesser quantities; they will buy cheaper brands, and switch loyalties at the drop of a discount.

The second impact is on costs. The question companies face is: should we protect margins, and hike prices risking the loss of volume growth, or protect volume growth and hike prices, but only by a little. Most companies have chosen the second option, especially as competition snaps at their heels. Take noodles, for example. A number of competitors have jumped in to challenge Nestle India Ltd’s Maggi brand. Its priority will be to protect market share and not protect margins in this scenario. The hope is that prices will eventually drop and margins restored to previous levels and profit growth will resume its upward march. But the reverse will happen if inflation keeps rising.

A bigger worry now is that globally, commodities seem to have run into a bull phase, both due to supply worries caused by poor weather conditions and speculative buying. That is even worse news for Indian companies if this is a trend and not a temporary blip. In the domestic market, some commodities such as milk and wheat are relatively protected from global blips. But non-food products are not.

Edible oil prices have been rising sharply in recent times, and palm oil futures ended 2010 at their highest level in 15 years, according to Bloomberg. Soya oil prices have shot up, due to fears of lower output. There is a general uptrend seen in the food commodity table.

What’s worse, plastic packaging is another significant cost for consumer companies. The consistent increase in crude oil prices is likely to trickle down to packaging costs as well.

The upshot will be that if consumer companies follow their past strategy of limiting price increases, their margins may come under more pressure. And, if they don’t, volumes will suffer. Either way, 2011 is going to be a tough year for food companies and for their investors, too.

Graphic by Yogesh Kumar/Mint

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