General Mills Downplays Rising Commodity Prices

Ken Powell, Chairman and Chief Executive Officer of General Mills said in a press release last week that management expected commodity cost inflation for the fourth-quarter 2009 ending May 2009 to be “well below the estimated full-year inflation rate of nine-percent.” The packaged food company, known for brands like Cheerios, Pillsbury and Betty Crocker, might need to re-think that calculus, as grain and oil prices continue to trend higher.

Entering March 2009, prices for corn, wheat, and oil had dropped more than 35 percent, 60 percent, and 75 percent in the past year as the global recession curbed demand for most commodities. Reversing this trend, corn and wheat for May delivery traded as high as $4.03 a bushel and $5.63 a bushel intra-day on the Chicago Board of Trade on Monday, the highest prices since January 20 and February 10, respectively. Benchmark crude for May delivery settled at $53.80 a barrel on the New York Mercantile Exchange, its highest level since November 2008, as energy traders speculated that the U.S. Treasury plan to rid banks of toxic assets would stimulate the economy.

Powell said although commodity prices have climbed about 25 percent over the past five years, the company has only needed to raise its product prices just eight to 10 percent, reflecting the success of its “holistic margin management” (HMM) initiatives, which include cost-savings initiatives, marketing spending efficiencies, and profitable sales mix strategies.

Operating margins slipped two hundred basis points year-on-year to 17.2 percent for the third-quarter ended February, which management attributed to higher commodity costs, an 11 percent increase in consumer marketing expenses, and unfavorable foreign currency exchange (a stronger dollar), according to the FORM 10-Q regulatory filing with the SEC. In my opinion, the weaker financial performance shows that the HMM efforts are not offsetting higher input costs.

Could the reality be that General Mills — like other food companies, such as Kellogg and Kraft Foods — keeps its price increases moderate because it fears losing market share to cheaper private-label offerings? As the benefits of lower commodity inflation recede — short of smaller package size initiatives — it is hard to grasp how the company anticipates delivering on promised margin growth in fiscal 2010.