Sunday, May 4, 2008

Retail Memo: Similar to What We've Argued About the U.S., Canadian Grocers and Food Industry Players Say 'Era of Cheap Food' Coming to an End At Home

Like has been the case in the United States, food and grocery prices in Canada have been relatively cheap historically, compared to the rest of the world.

Canada, like its U.S. neighbor, benefits from a robust agricultural sector. The proximity of the two nations, along with strong trading agreements, also allows the two North American countries to trade agricultural commodities like wheat, corn, rice and soybeans, as well as finished food and agricultural products, with each other at low costs because of the free trade agreements and relatively short transportation distances.

Like David Ryzebol, an executive for Safeway Canada said in an article in today's Calgary Herald, a daily newspaper based in Canada's largest agricultural region, "In Canada we have an extremely cheap, efficient foods system."

"We've seen huge increases in prices of fuel, prices of homes, we've seen costs to grocers go up, but as a rule we've kept prices very low," Ryzebol says, regarding how Canada's supermarket operators have been able to hold the line despite soaring prices of agricultural commodities and food and grocery products made from them.

However, like in that other, nearby "era of cheap food" nation the U.S., despite being able to hold the line in terms of dramatic food and grocery price spikes, Canadian grocers too are having to raise the retail prices on fresh and packaged foods across their store aisles regularly, as the costs of wheat, corn, rice and soybeans continue to soar in costs globally.

As we've detailed before in Natural~Specialty Foods Memo, supermarket chains and independents in the U.S. have been holding the line in terms of reflecting the full price increases they get often weekly on food and grocery items. Canadian grocery buyers and category managers have been doing the same, as directed by their bosses.

For example, lets take bread. Since January, supermarket chains in the U.S. and Canada have received a series of price increases from their fresh bread suppliers of about 15%. However, the majority of the grocery chains have only increased their retail prices on bread by about 10-12%, absorbing the remaining the 3-4% out of gross margin.

This behavior can't last forever though, especially in the case of publicly-traded supermarket chains which must meet analysts' guidance for quarterly sales and profit numbers or risk having their stock value plummet.

And, despite holding the line on retail prices, the costs of basic food and grocery products are still soaring at the supermarket.

Eggs for example have increased by 30% since January, 2008. Milk and cheese are up by double-digits as well. And even though the grocers have held the line on bread, a 10-12% price increase is still serious for consumers.

Packaged goods made with wheat, corn, rice, soybeans and other staples also are soaring. It's predicted that overall food costs are about 4% higher in the U.S. and Canada this year, compared to last. Further, food prices are expected to increase by 5% overall this year.

That's significant for consumers who also are faced with a perfect cost of living storm: higher food prices, soaring gasoline and home energy costs, tight credit and rising unemployment.

The 4% overall food price increase, which doesn't look all that bad on the face of it, doesn't tell the complete story however. That's because, as we explained above, most everyday grocery items like bread, milk, eggs and other staples are experiencing double-digit price increases at the supermarket.

In today's Calgary Herald story, Dave Wilkes, the senior vice president of the Canadian Council of Grocery distributors, says Canadian grocers' and food producers' ability to hold the line on huge price increases is wearing thin.

"We really are experiencing a sort of perfect storm--a combination of changing fuel prices and commodity costs--that is changing the costs of the food industry," Wilkes says. "There's a variety of factors leading to this change and none of these are expected to change over the short term for sure."

Wilkes' analysis that these factors are changing the costs of the food industry mirrors our argument here on Natural~Specialty Foods Memo that what has been essentially called the "era of cheap food" in North America and to a lessor extent in other parts of the rich, developed world is coming to an end.

We expect to see continued soaring prices for basic commodities like wheat, corn, rice and soybeans for at least the next two years, before supply starts to better meet demand. At that point we think for a while in the western world at least we will see annual cost of food increases more on the order of 2.8 -to- 3% or so.

However, the huge increases of over 60% for rice in just the last five months, 100-plus% for wheat in the last three years, 50-plus% for corn in the last two years--plus similar whopping price increases to come this year and next--will be built into the costs of such commodities by the time prices level out in two years.

As a result, we think it will be fair to say at that point the "era of cheap food" in North America and in other rich, western nations has come to an end. Food prices in Western Europe are already considerably higher than in North America and are increasing by about the same percentages, for example.

Keep in mind, much if not most of the dramatic price increases in these basic food commodities is because of the soaring costs of oil, gasoline, diesel fuel and other fuel energy sources, which there is no end in site of at this point in time.

Increased demand for more western-like foods by consumers in rapidly-developing China and India also is in part a cause, as is in the case of corn, particularly in North America, the shifting of a significant percentage of crops from food-grade corn to fuel-based corn.

However, the major cause of the escalating cost of food is the soaring price of fuel, which is used in every aspect of farming--from powering farm equipment and trucks to get crops to market, to delivering finished food and grocery products along the logistics chain and more.

With oil now well over $100 barrel, and continuing to climb, fuel--and how much and fast it will continue to increase in price--is the big variable in our analysis in the food price increase situation.

Keep in mind, just five years ago a barrel of oil cost less than half of what it currently is selling for on the market today. Further, for a number of years in the 1990's, we were seeing $10 -to- $15 a barrel oil.

The dramatic climb to $100-plus a barrel oil, with the resulting across the board price increases in gasoline and other energy sources, can't be emphasised too much in our analysis as being the leading cause of soaring food prices.

The silver lining for consumers is that the North American retail food and grocery industry is extremely efficient and competitive. If not for that fact, food prices would be much higher in the stores than they currently are.

Many leading supermarket chains are rapidly adding renewable energy sources like wind and solar to their distribution facilities and even store rooftops as a way to decrease the percentage of fossil fuels required to power their operations.

Grocers and distributors like Safeway Stores, Inc and others also are converting their truck fleets from petroleum-based diesel fuel to bio fuels, which of course begs the corn ethanol question, but is a wise move we believe because the next generation of bio fuels will be made from grasses and other non-food crops.

Leading supermarket chains and independents also are employing efficiencies so they can offer better price promotions on food and grocery items to consumers during this period of soaring food prices.

Hotter weekly retail ads are coming out in both Canada and the U.S. designed to get cash-pressed shoppers in the supermarket doors, where once inside they also will buy some higher margin items it is hoped by the grocers who are willing to reduce margins on the promoted items because the industry is so competitive.

Numerous supermarket and mass merchandising chains like Kroger Co., SuperValu, Inc., Wal-Mart and others in the U.S. are offering consumers a 10% bonus if they redeem their soon to be received tax rebate checks at the stores for gift cards.

Tax rebate checks ranging from $300 -to- $1,200 for every American who filed a 2007 income tax return started going out in the mail last week.

These and many other U.S. grocery chains will add at least 15% onto a consumers gift card if they cash the check at their stores and convert it to a store gift card that must be spent with the grocer. That's an extra $30, to as much as an extra $120, for shoppers who do so.

Such a bonus can go a long way for many consumers right now. It's also a way to gain sales for grocers in these bad economic times. Further, it's an example of that industry innovation in terms of trying to hold the line on price increases we mentioned earlier.

As the "era of cheap food" comes to an end, we will see food and grocery retailers, as well as suppliers, come up with numerous ways--such as the move towards a "greener" food industry, creating increased efficiencies, and other innovations yet to be thought of--to continue to hold the line within reason on increasing food prices.

Key to doing so across the board though is finding a solution and alternative to North America's heavy reliance on petroleum and the fuels which are made from it.

That's why, as one example, it's essential that food and grocery retailers and suppliers move even faster in the areas of renewable energy sources, conservation, alternative fuel uses and other "green" practices.

Doing so is an economic necessity as much as an ethical or environmental imperative. After all, there is no question the "era of cheap fossil fuels" has ended.

No comments: