Food companies are among the unluckiest casualties of the new era of high commodity prices because they are hit by a double whammy: not only are they suffering the pain of expensive oil but they also are paying unprecedentedly high prices for the ingredients that go into their products.
No company has escaped unscathed – in part because none anticipated the surge in commodity prices that has occurred over the past year and a half.
Companies initially coped with higher costs by pushing through price increases to retailers (some have raised prices by as much as 20 per cent over the past year) but they are now feeling the effect of these increases on sales volumes, which have been dropping as consumers cut back on grocery shopping and switch to non-branded foods (such as those made by supermarkets under their own labels).
To keep hitting profit targets, companies are now becoming cleverer about costs.
Cadbury, the confectionery group, has emerged as one of the most successful cost managers this year, having produced strong organic sales growth of 7 per cent and profit-margin growth of 210 basis points in the first half despite being taken unawares by soaring commodity prices.
In July, Todd Stitzer, Cadbury’s chief executive, said: “Commodity costs are proving a stronger challenge than we had foreseen when we laid out our [cost-cutting] plans in June of last year.”
Cadbury’s cocoa prices were up 37 per cent in the first half compared to the previous year; sugar was up 29 per cent; milk was up 26 per cent; and crude oil was up 50 per cent (raising transport, production and packaging costs.) The oil price increases have a lag effect, because the company takes out 12-month hedging contracts. This time last year, when Cadbury was signing oil-purchase contracts, oil cost around $60-$70 per barrel (it now costs around $100).
Cadbury has warned investors it will take a bigger hit to profit margins from commodity costs in the second half of the year than the first due to the delayed impact of the oil-price increase.
Ken Hanna, Cadbury’s chief financial officer, told analysts in July: “One factory in the US has just had its energy bill re-cut for another 12 months at $130 a barrel, and it was $65 a barrel a year ago. That one factory is going to cost us a substantial amount of money.”
Still, Cadbury’s margin growth has outstripped competitors such as Reckitt, Unilever, Danone and Nestlé. “Cadbury [emerged] as the outstanding margin performer of the first half,” says Martin Deboo, analyst at Investec.
The company achieved good margin growth by getting rid of unprofitable products and focusing on more profitable ones (such as chewing gum), cutting back on promotions, changing its packaging and raising prices. Some 6 per cent of the sales growth it delivered in the first half of the year was obtained by these methods, with just 1 per cent from higher sales volumes.
Investec estimates only 15 per cent of Cadbury’s total organic growth came from sales volumes in the first half of the year, compared with 33 per cent in the first half of last year.
By ditching certain promotions, such as “2 for 1” specials over Easter, it lost sales volumes, but improved profits. It is also trying to save money on packaging, such as cutting back on the amount of aluminium used as foil in packets of its chewing gum.
And as a global business it can also be selective about which countries it raises prices in. Mr Hanna said in July that Cadbury had put prices up 12 per cent in some markets and 3 or 4 [per cent] in other markets.
Cadbury is by no means out of the woods. The company has warned that if cocoa prices stay at current high levels, it will raise chocolate prices next year after increasing them by some 5 per cent this year. (Cadbury wil not disclose exactly how it hedges cocoa.)
But its readiness to be creative about how it tackles higher costs has won the praise of analysts. Andrew Wood, analyst at Bernstein Research, said this year: “Management’s new aggressive stance on pricing seems to be paying off.”