Rising Commodity Costs Put Consumer Firms in a Bind

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Ahead of the largest consumer goods conference, CAGNY, I am here with Erin Lash; she is an equity analyst at Morningstar. We'll take a look at some of the themes that she thinks are going to be at the conference, and if there are any opportunities in the consumer product space right now.

Erin, thanks so much for taking the time today.

Erin Lash: Thank you for having me.

Glaser: So let's start off big picture. What are some of the big ideas that you're expecting to hear from a lot of these companies over the course of the week?

Lash: One would be related to competitive pressures. Obviously, over the past year consumers have been strained, and so promotional spending has really picked up intensity. However, input costs are going up, and so at this point in time consumer product companies are really faced with a challenge, whether they actually lower prices further to drive volumes or maintain volumes. Or whether they actually raise prices to offset some of the pressures that they're seeing with regards to commodity costs.

Glaser: One of the things we hear from our analysts who cover the retailers is "private label, private label, private label," and the idea that consumers are going to store brands. Is that part of the competitive pressure landscape or is it more competing amongst the branded products?

Lash: Private label is obviously, more of a force to reckoned with today than it was five, 10 years ago. Retailers such as Wal-Mart, Costco, Kroger have really been investing behind their private label brands, and so you've seen an improvement in the quality or at least the perception of quality from a consumer's perspective.

So, branded manufacturers really have to take into account the price gap, the level of their prices versus private label. And that's definitely a serious consideration when they're deciding whether to increase the prices on their products and the effect that that could have on their volumes if consumers trade back down to private label offerings.

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Glaser: Now, is there any concern that these commodity costs--that there will be no cap to them. That were at the start of a period of runaway inflation and that this cost is going out of control? Or do most of these companies feel like this is a kind of a short-term problem, but that prices will eventually come back down?

Lash: Well, there are two things that are driving the commodity costs higher at this point. Obviously there are short-term supply constraints. So whether that's bad weather or whatever, they're having an affect on prices right now. However, over the long-term, we still feel like commodity costs continue to be elevated, primarily because of increased demand in emerging and developing markets. So this isn't a problem that's going to subside to a meaningful degree. It's a problem that these companies are going to have to deal with, maybe not to the degree that they are right now, but it is a problem that they they'll be faced with for some time to come.

Glaser: But certainly the plus side of improved demand from emerging markets is that you can sell these consumers some of these branded products. What are some of the strategies that these companies are doing now, or you think they could rollout, to really tap those emerging consumer markets?

Lash: Obviously they are just trying to get in with the consumer. The growing middle class in these markets is really having an uptick. Obviously, this is a benefit on the packaged food side; food is essential--everyone needs to eat--and so you are seeing increased demand for these offerings. And you're seeing companies try to get in maybe by having joint ventures with companies in those markets or by making straight out acquisitions to build the footprint, because there are differences in terms of cultural taste and preferences.

As commodity costs go up, and as these companies are faced with higher costs, emerging markets is one of the areas where they are potentially going to be raising prices. However, the necessity of those offerings could really sway whether these consumers, who may or may not be loyal to a brand or a product at this point, continue to purchase that. So maybe they'll continue to buy the food offerings, but maybe they'll pull back in some of the household and personal care lines. So, really resonating and trying to get in touch with the taste and preferences in those markets is very essential at this point.

Glaser: Let's take a look at some individual companies, what names do you think are attractively priced right now?

Lash: We think Procter & Gamble in the household and personal care space is attractively priced. The firm is really focused on driving costs of their business, and we feel that they do have some leverage to do that at this point. In addition, they are investing in their products and really trying to garner a broad product portfolio that resonates with consumers. They have a diverse portfolio, and they are geographically diverse, so we think that they are an attractive stock that investors should consider at this point in time.

Glaser: Certainly P&G is a stalwart, one that's probably be on the lot of investors' radar screens. For those looking to take on maybe a little bit more risk with the lesser-known name, what do you think would be a good choice for them?

Lash: Yeah, investors that have a higher risk tolerance, we would suggest Dean Foods. Dean has been facing intense competitive pressures and rising commodity costs, and we think that the markets' fears right now are overblown. We think that while pressures will persist and while it's not for the faint of heart, we think there is about 50% upside to the shares right now. And we hope to gain additional insights from both companies, as they will both be presenting at CAGNY.

Glaser: Erin, thanks very much for talking with me. We're looking forward to your research coming from that conference.

Lash: Thank you for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.