Mixed impacts across the food sector as inflation hits consumer spending

• US companies see strong food grocery sales as consumers focus on essentials
• Food manufacturers report smaller gross margins as rising input and operating costs outpace sales growth and price increases
• Consumer food price inflation ticked higher in June, reaching 10.4% in the US and eurozone and 9.8% in the UK

Consumers are changing their spending habits as prices continue to rise for food and other consumer goods. In a series of recent investor communications, food, retail and FMCG companies report consumers are prioritising food and other essentials as inflation eats into household budgets. Consumers are also rethinking their essential spending, in some cases switching to cheaper alternatives but still sticking to certain premium brands as "affordable indulgences".

This is creating a challenging landscape for food manufacturers. Companies are facing their own inflation challenges with higher input and operating costs. And cutbacks in consumer spending are limiting the ability for some companies to pass these costs on to consumers, hitting profit margins as a result.

Consumers prioritise groceries, switch to cheaper products as inflation hits home

On 25 July, US retail giant Walmart reduced its profit forecast as consumer shopping habits shift in response to inflation. The company said customers are spending more on essentials such as food but forgoing discretionary spending items like electronics and clothing. The company expects overall US sales to increase 6% in the second quarter, but a larger share of sales is expected to be in its grocery category, which is less profitable and expected to weight on the company's earnings. Walmart now expects earnings per share for its upcoming second quarter to decline 8-9%. The company had previously projected earnings per share to be either flat or slightly up.

With consumers prioritising food and other essential spending, US grocer Albertson's reported better-than-anticipated results in its first quarter of 2022 (the 16-week period ended 18 June). The company's net sales and other revenue for Q1 2022 was $23.3 billion, 9.6% higher compared with last year. The company reported 6.8% growth in identical sales (for stores operating during the same period in both the prior and current fiscal year). Sales growth outpaced rises in the company's cost of sales, resulting in a gross margin of $6.5 billion, 5.7% higher compared with the same period last year despite a decline in the company's gross margin rate from 29.1% to 28.1%. In Albertson's earnings call, CEO Vivek Sankaran noted that customers were switching from branded to cheaper private-label products while at the same time continuing to buy premium options in certain categories.

Food companies reckon with higher operating costs in a changing demand landscape

Consumer goods giant Unilever grew sales 7.3% in its foods & refreshment category in the first half of 2022. The company reported an 8.3% increase in prices but a 0.9% decline in sales volume. Higher input costs are eating into the company's margins. Unilever reported its overall underlying operating margin declined 180 basis points (from 18.8% in H1 2021 to 17% in H1 2022). It also reported its overall gross margin rate declined due to "very high inflation and input costs" which were only partially offset by price increases. The company's underlying operating margin for food and refreshments declined 170 basis points, although it did not disclose what these margins were. The decline in underlying operating margin for food and refreshments was attributed to a lower gross margin rate in the category.

In Nestle's half-year report for 2022, the company reported organic sales growth of 8.1% and that it had increased pricing by 6.5% in response to cost inflation. The company's gross margin rate declined by 280 basis points (from 48.8% to 46%) due to inflation pressures. Higher commodity, packaging, energy, and freight costs were all listed as contributing factors.

Coca-Cola's most recent Q2 2022 (the three-month period ended 1 July) results also reported pressure on profit margins but saw strong revenues and sales volumes. The company saw a 12% increase in net revenue in the second quarter, but its operating margin fell to 20.7% compared with 29.8% the previous year. The company reported higher operating costs as well as a significant impact from "currency headwinds" - negative impacts on the value of sales in international markets due to a stronger US dollar. Notably, Coca-Cola reported 8% growth in sales volumes, which the company attributed to growing recovery in away-from-home sales. The overall growth in volumes suggests consumers are sticking with Coca-Cola brands even as they trim spending in other categories.

Confectionery company Mondelez International also reported strong results for its second quarter (the three-month period ended 30 June) on robust demand for its biscuit and chocolate brands. The company saw net revenue increase 9.5% to $78.274 billion. The company's chocolate category grew over 9% in volume. The company said in the current environment, consumers see chocolate as an "affordable indulgence".

Input cost inflation remains at historic highs in the food sector

Input cost inflation in the food sector is showing gradual signs of slowing but remains at near-peak levels. The FAO food price index, which tracks global food commodity prices, sat at 154.2 in June. This marked the fourth month of marginal declines from the peak of 159.7 in March, but prices remain significantly higher than the level of 141.1 recorded in February prior to the outbreak of the war in Ukraine.

In June, S&P Global Purchasing Managers' Index (PMI) data showed a slight decline in the number of companies reporting rising input costs among food and beverage manufacturers. The index fell to 73.5 in June from a record high of 75 in May. Any measure above 50 in the index indicates rising input costs, and 73.5 remains extremely high by historical standards.

Consumer food prices continue to rise

In the US, annual food price inflation in June was 10.4%, according to Consumer Price Index (CPI) figures from the US Bureau of Labor Statistics. Food at home (grocery) saw higher inflation at 12.2% in June, while food away from home (restaurants, foodservice) registered an annual inflation rate of 7.7%. The US Department of Agriculture (USDA) now forecasts US food price inflation for 2022 between 8.5-9.5% higher than 2021, which would be the highest food price inflation rate since 1979.

Consumer food price inflation remains a global challenge. In the eurozone, annual food and non-alcoholic beverage price inflation was 10.4% in June, according to the most recent Harmonised Index of Consumer Prices (HICP) data from the European Central Bank (ECB). In the UK, annual price inflation for food and non-alcoholic beverages was 9.8% in June, according to figures from the country's Office of National Statistics.

Posted 01 August 2022 by Lee Bridgett, Analyst, Food Retail and Manufacturing, S&P Global Commodity Insights

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.