By Martinne Geller and Jessica Wohl
NEW YORK/CHICAGO (Reuters) – Consumer staples companies have a problem. It costs more to make everything from soup to soap to soda, but when they raise prices they turn off consumers and strain their relationships with Wal-Mart Stores Inc, their biggest customer.
For some companies, like Clorox Co and Kraft Foods Inc, the problem can be comparatively easy to handle. They either have brands that consumers like, and therefore Wal-Mart needs, or they are big enough to have significant negotiating power.
But Wal-Mart is now pushing its grocery suppliers harder to offer consistently low prices, instead of timed promotions or “rollbacks.” That means food companies are unlikely to be able to pass through more price increases and will be forced to pull other levers, such as cost-cuts to protect margins or product innovation to drive sales.
And with many consumer goods stocks trading at a premium to the broader market , analysts say the risk is on the downside. In particular, they see pressure on companies with second- or third-tier brands, such as ConAgra Foods Inc, whose Hunt’s ketchup competes with Heinz.
Shares of makers of packaged food that raised prices too much, like General Mills Inc, whose products range from Cheerios cereal to Progresso soups, also may face pressure.
Consumer staples companies that make up two Standard & Poor’s indexes — the S&P 1500 Packaged Foods & Meats Index and the S&P 1500 Household & Personal Products Industry Group Index — trade at nearly 16 times expected earnings, while companies in the S&P 500 index trade at 12.8 times expected earnings.
“I think we reached the wall in terms of raising price. Consumers can’t take any more,” said Edward Jones analyst Jack Russo, citing recent Nielsen data showing correlations between price increases and declines in sales volume.
“A lot of these companies are going to have to get back to basics and not raise prices much, and if they want to grow sales they’re going to have to do it through innovation, or being razor-sharp on pricing.”
For example, General Mills’ sales volume fell 11.3 percent in the 12 weeks ended February 18 after the cereal maker raised its average selling price by 11.5 percent with a combination of price hikes and a mix of higher-priced goods, Russo said, citing Nielsen.
One silver lining is that cost pressures are abating, as prices of many commodities, among them corn and wheat, have eased in recent months. Among packaged food stocks, Edward Jones recommends General Mills, Kellogg Co and McCormick & Co. It has a “Hold” rating on Hormel Foods, ConAgra, Hershey Co, Campbell Soup and Kraft Foods Inc.
FROM “ROLLBACKS” TO “EVERY DAY LOW PRICES”
For Walmart, the biggest grocery seller in the United States, lowering prices on a long-term basis can help it convince shoppers that it is the best place to go for everyday items.
With gasoline prices climbing and many shoppers living from paycheck to paycheck, Walmart wants to win a larger share of shoppers’ limited spending , after having lost some customers to dollar stores during the last recession.
“We want to work with vendors on that to see if we can take a price lower and leave it there permanently,” Wal-Mart Chief Financial Officer Charles Holley told reporters last month. “The price image for a customer is very important.”