Rapidly rising food chain costs pose quandary for food manufacturers; raise inflation worries

Rapidly rising agricultural producer price inflation, as reflected in last week's PPI (Producer Price Inflation) for March, poses a conundrum for food manufacturers about whether to absorb these cost increases or try and pass them on to financially constrained consumers, fanning inflation worries.

John van Tubbergh, Sector Head for Consumer, Food and Agri at RMB, said that recently, many of the large food manufacturers have cited soaring prices of key agricultural products – used as inputs in the manufacturing of basic consumer foodstuffs - as a real threat to margins.

Agricultural producer price inflation accelerated to 12.3% year-on-year in November 2020, before settling at a still high 7.2% in March 2021.

"Digging deeper into the constituents of this figure, the inflation rates for cereals and other crops, as well as dairy products are 17.2% and 12.6% respectively", he noted. "Producer price inflation for live animals and animal products is 9.8%."

Combined cereals, dairy and animal products make up nearly 60% of the agricultural producer price basket.

Price pressures at the agricultural level are also beginning to drive manufacturing costs up.

From subdued levels of around 4% last year, manufactured producer food price inflation has quickened from 6.9% year-on-year in February to 8.1% in March. This rate now well exceeds CPI food price inflation which means gross margins of food manufacturers are getting squeezed.

"Amid a still weak economy with households financially under strain this leaves food manufacturers with some difficult decisions to make," van Tubbergh said.

"Food manufacturers have already responded by cutting internal costs and optimising processes in order to help reduce the pressure on margins. For instance, we are increasingly being asked by clients to hedge against cost increases resulting from soaring agricultural commodity prices," van Tubbergh added.

Work-from-home dynamics have given food manufacturers some wiggle room.

"Due to Covid-19 and recent lockdown restrictions, many consumers are staying at home and consuming more basic groceries. Taking advantage of this increased demand food manufacturers have been able to raise selling prices," said Ettienne Le Roux, Chief Economist at RMB.

But even so, it will be difficult for them to continue hiking prices as much as they would like.

"South African consumers face many headwinds, key among them higher fuel prices, as well as increased municipal rates and taxes. All this at a time when many working individuals have also had to accept zero salary increases, and even worse, outright pay cuts because of the severe economic impact of last year's Covid-19 lockdowns".

"Consumers will therefore be very sensitive to any further sharp price increases, a dynamic food manufacturers no doubt would be aware of in today's ever more competitive corporate landscape," Le Roux concluded.

ENDS