16 Mar 2022 Ukraine invasion puts local food producers in a tough spot

As the price of wheat, maize, edible oil and fuel surge in the wake of the Russian invasion of Ukraine, JSE-listed food producers and grocery retailers face a tough balancing act.

The war has sparked sharp increases in produce such as wheat. JSE-listed grocery retailers and food producers are expected to try to keep costs hikes on basic food items to a minimum, but treats could see sharp surge in prices.

Companies cannot absorb all the sharp price hikes in essential food commodities, but if they pass on rampant price increases to consumers, they run the risk of seeing demand plummet, especially for discretionary items such as biscuits and treats, and could lose customers to rivals, analysts have said. 

Casparus Treurnicht, research analyst and portfolio manager at Gryphon Asset Management, said food producers and retailers are going to “take significant strain” in the coming months, as the steep rise in commodity prices has created a “perfect storm” for them, as well as packaging groups and logistics players across the value chain.

Treurnicht said smaller, more marginal food producers with weaker balance sheets will come under immense pressure, and some may fall by the wayside. Even big food producers such as Tiger Brands and AVI will take a hit because of the pressure of rising costs, he added.

Elasticity of demand

Retailers will also have to pass on costs to consumers, but this brings its own dangers for a higher end retailer, for example, as customers could opt to shop elsewhere for bargains.

And some costs are easier to pass on than others.

Referring to the economic theory of elasticity of demand, Sasfin Wealth senior equity analyst Alec Abraham said for some basic foods, such as bread, if prices go up, it doesn’t really affect volume and demand because people have to eat, but in the case of “something that is a nice to have, such as a Swiss roll”, the “elasticity of demand is greater”. 

“In other words if the price goes up you can easily stop buying it. For example, AVI, which also produces biscuits: if a consumer is running short of cash you are not going to buy biscuits so with these items the volumes could drop a lot more than with bread, for instance.”

Jacob van Rensburg, head of research and development at the South African Association of Freight Forwarders, said retailers and food producers will have more leeway for price increases in essential foods as there is “inelastic demand” for essentials such as wheat, sunflower oil and crude oil. 

“Therefore the demand will not react too much on the price. Consumers will have to absorb the cost.” 

Reporting results for the six months ended December 31 2021, AVI said this week its divisions Entyce Beverages, which houses its tea and coffee products Five Roses and House of Coffees, and Snackworks, which includes the Bakers biscuit brand, “face significant inflationary pressures from rapidly rising commodity prices with further selling price increases required to preserve gross margins”.

“If sustained, the cost pressures will accelerate and the balancing of margin and volume will become especially challenging in 2022.”

Tiger Brands said that “in recent days, the international price of wheat has spiked significantly along with a surge in the international price of sunflower oil. Prolonged disruption to exports from Ukraine and Russia is likely to further push prices to new all-time highs that will translate into inflation on the shelf over time.”

In addition to using locally grown wheat, Tiger sources wheat from several markets, including Russia and Ukraine, but it does not expect disruptions to its supply of bread to customers in the short term.

Abraham said there is no doubt grocery retailers and food producers are going to come under pressure in the coming months as they battle these inflationary pressures, but producers are probably in a more vulnerable position. 

“Food producers have to try and run efficient volumes through their factories so they are more inclined to take a hit to try and not lose volumes and keep factories running efficiently. The retailers don’t have that imperative so they can squeeze the producers.”

But Abraham said retailers will also face pressure as they seek to gain market share by all “investing in keeping prices lower” as they at the same time contend with a higher inflationary environment.

One retailer planning to continue to absorb some of the increases is Shoprite. CEO Pieter Engelbrecht told an investor presentation this week after the release of its results for the 26 weeks ended January 2 2022 that the group “will continue to subsidise essential foods”, adding that Shoprite has sold bread for “R5 since 2016 and we will continue to do so, selling 1-million loaves a week”.

Even before the war in Ukraine caused commodity prices to spike, inflation had been a major concern for retailers, with Engelbrecht saying fuel went up “over 30% over the past 12 months”.

Shoprite had managed to contain its fuel cost increases to 4% during the results period, by fitting more than 900 of its refrigerated trucks with photovoltaic panels to save on fuel.

Woolworths said it is striving to keep “price increases to an absolute minimum” but “there are, however, circumstances which often lie outside our control which have an impact on price adjustments”.

Due to the Ukraine-Russia crisis, it expects to see cost impacts in oil commodities, freight and transportation. “We will only accept a price adjustment as a last resort after exploring all avenues to prevent one,” said the group.

Pressure, pressure, pressure

Wandile Sihlobo, chief economist of the Agriculture Business Chamber of SA, said the Russia-Ukraine war started “while we were already in an environment of elevated commodity prices” and that it will add “further upside pressures to food companies and consumers”.

Sihlobo said since the start of the war on February 24, South African yellow and white maize spot prices have increased roughly by 3%, trading at about R4,201 and R4,034 per tonne, respectively.  On a year-on-year basis, yellow maize is up 21% and white maize up 20%.

He said in the case of wheat, spot prices increased by 5% since February 24, trading at about R6,750 per tonne by Thursday this week. This is up by about 27% from the  corresponding period last year.

Meanwhile, Brent crude oil was up 13% since the start of the war, at about $114 a barrel in the latter part of the week. It is up 72% since the start of March 2021.

Source: BDLive.co.za