Fork it Over: As Food Inflation Ticks Higher, 4 Sectors to Watch

Retail food inflation is expected to accelerate modestly in 2018, according to some industry experts. What might that mean for investors?

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Everyone has to eat, and wherever you do it this year—at home, in your car, at your favorite restaurant—prepare to pay more.

Retail food inflation is expected to accelerate modestly in 2018, professionals say, with certain categories, such as eggs and pork, rising even faster. 

In December, the consumer price index for meats, poultry, fish and eggs posted its largest monthly increase since June 2015, according to the Labor Department.

What’s in store for 2018? Generally speaking, the strengthening global economy may bode well for the industry, some professionals say. But there are many factors constantly at work across our vast food production and distribution system, such as:

  • energy costs,
  • commodity markets,
  • weather, and
  • global economic trends.

What may be beneficial to the bottom line of a meat packer, for example, may not necessarily be good news for a grocery or restaurant chain (or the consumer). Here are four specific food industry sectors that some industry experts suggest investors may consider keeping an eye on this year:

1. Supermarkets

Like anything in retail, grocery chains are constantly battling over price and market share in what’s historically a tight-margin business. Add to that the expanding presence of big-box stores and, more recently, e-commerce platforms, and you have many players vying for your food dollars.

“The retail environment won’t get much easier as merchants continue to compete on price,” Morningstar analyst John Brick says in a recent report. In a negative scenario for supermarkets, “we see the competitive landscape intensifying and retailers responding by lowering prices to drive store traffic,” he adds.

Still, some analysts see key industry metrics, such as comparable-store sales, remaining positive in 2018 as an anticipated pickup in food inflation drives a bounce-back from margin-killing deflation in 2015-16.

The inflation outlook suggests “relief for the food industry, which has suffered from several years of deflationary food pressure,” says Joe Agnese, an analyst with research firm CFRA.

2. Restaurants

Financial performance of restaurants has long been considered a gauge of economic strength or weakness. U.S. restaurants posted record revenue of $799 billion in 2017, up 4.3% from 2016, according to the National Restaurant Association, and the industry appears poised for further gains in 2018.

Restaurant operators are becoming “increasingly confident about business conditions in the months ahead,” the association said in a report.

Hudson Riehle, senior vice president of the association’s research department, expects “moderate” growth in U.S. restaurant sales in 2018, with average menu prices rising in the neighborhood of 2% (after increasing 2.3% in 2017).

But, similar to supermarkets, greater competition looms. There now are more than 1 million restaurant locations nationwide, a number that’s been increasing, on a net basis, by about 1% a year, he says.

“It’s getting more and more competitive,” Riehle says. Food and beverages account for only about a third of the total expenses for a typical restaurant, with labor costs accounting for a big chunk of the rest. Another factor: so-called third-party food delivery services are “proliferating,” Riehle says. About 63% of restaurant traffic in 2017 was “off-premises,” he adds. Delivery is a “a lot of the focus” now.

3. Food Processors

Many of these companies, including meatpackers, grain millers and packaged food makers, buy raw or unprocessed commodities, such as hogs, corn and wheat. As such, they must navigate the weather's impact on crops, volatile commodity prices and domestic and global demand.

Cattle prices, for example, have been rising since late last summer as a weaker U.S. dollar helped fuel exports (American beef exports are expected to rise nearly 4% in 2018 after surging over 12% in 2017). But more animals are being fattened for slaughter in the major U.S. beef-producing states, according to recent numbers from the USDA, and cattle futures prices on the Chicago Mercantile Exchange have been lower in some deferred-month contracts versus near-term contracts, which could indicate lower prices expected by spring and summer. 

Meanwhile, hog futures have climbed 31% since the end of September, and the market may be reflecting expectations for even higher prices in May and June, just in time for the summer grilling season.

“A weaker dollar will support increased ag exports and be supportive of inflation in 2018,” CFRA’s Agnese says. “Packaged foods firms will look to leverage strong brands and increased marketing to support pricing increases in an effort to offset higher food costs.”

The biggest grain and soybean processors may be grappling with different circumstances, as record harvests led to a global supply glut that depressed trading and eroded profits.

4. Food Service/Food Distributors

The suppliers for hotels, restaurants, stadiums, schools and other businesses and institutions make up a “highly competitive and fragmented” industry that appears ripe for consolidation, Morningstar’s Brick says in a report.

“Food service distribution is fiercely competitive at a local level, as the industry boasts 15,000 smaller distributors that could offer more tailored services and specialty products,” Brick says. The fragmented market “presents an opportunity for larger companies, given their appetites to consolidate.”

Beyond any consolidation, food distribution performance hinges, to a large extent, on its restaurant customers.

“In a bull-case scenario, we believe strong restaurant traffic trends across the industry could support faster sales growth” for food service, Brick says. The flip-side, Brick says, is the “vast array of options.” The average restaurant sources from 12 different suppliers, “which we believe reflects the aggressive competitive landscape and could constrain profitability over the long term.”

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