Will the correction in commodity prices boost GIC margins?

Has CPG ingredient inflation peaked?

I can only speculate if the recent pullback in commodity prices will continue, but with crude oil off its highs, crop prices well below their highs, numerous supply chain issues underway resolution, with retailers slashing prices to eliminate bloated inventories and freight spot markets under pressure, inflation may not stay at its 40-year high for much longer. Agricultural futures are reacting to the expectation that bumper crops could offset the disruption of the war in Ukraine, and the drop in oil prices reflects a recent increase in production as well as the destruction of demand caused by the price increase.

Over the past week, corn futures prices for December 2022 delivery have retreated to their lowest levels since Russia invaded Ukraine. Source: Barchart.com, Inc.

A recovery in the CPG gross margin?

Over the past 18 months, most CPG companies have seen their costs rise faster than expected and at a faster rate than they could pass those costs on to the retail channel. As a result, gross margins of CPG companies have come under pressure with a contraction of several hundred basis points on average.

As some input costs stabilize and stronger retail price increases take hold, CPGs are eager to stop the margin squeeze. So far, public GICs have mostly underlined their hope that they can recoup their increased dollar costs over the next year with higher retail prices. (The implication is that gross margin, as a percentage, will continue to contract).

Since retail prices move more slowly than input costs, it stands to reason that if GIC margins contract when commodity prices rise, margins should rise as commodity prices fall. But that requires CPGs to be nimble when dealing with retailers. If commodity prices stop rising, the window could close on the ability of GICs to fully pass on their costs to the retail channel. Potentially, retailers will only agree to price increases if they can independently see raw material and ingredient prices increase when they conduct their own audits of supplier price proposals. GICs have successfully lobbied for big price increases lately – for example, General Mills’ forecast for a 15% increase in retail prices over the next fiscal year.

Given that retail prices move more slowly than ingredient and raw material costs, it could still be several months before consumers benefit from a break in food prices in stores, even if the recent decline in commodities turns out to be the start of a trend. With retail prices still rising, the elasticity of demand remains perhaps the biggest uncertainty for the CPG industry in the months ahead. So far, most GICs have indicated that elasticities remain below historical levels, although most expect them to increase in the future.

Freight rates on the spot market (green line) have fallen sharply since the first quarter. Lower spot rates generally lead to lower rates in the contract segment (blue line), the market in which most GICs participate. Source: FreightWaves SONAR

Will Amazon become a CPG juggernaut?

Most CPG items are still purchased at grocery stores or big box retailers. However, there is a large and growing demographic of mostly busy professionals who prioritize convenience and “use Amazon for everything.” Once a household subscribes to Prime and considers the value of wasted time associated with shopping at physical stores, purchasing CPG items on Amazon becomes justifiable for many.

This Prime Day, Numerator, a data and technology company, expects Amazon’s market share of CPG sales to be at least 20%, its highest on record, and above the Amazon’s market share on Prime Day 2021 and Prime Day 2020 of 19.1% and 18.3%, respectively. On normal days, Amazon’s share of CPG sales is around 4-5% and continues to grow.

As Amazon becomes a bigger player in CPG sales, I expect this will present opportunities for smaller and emerging brands to take share of the largest and most popular national brands. established brands that have long occupied high-end storage space at top retailers. The trend is also increasing the importance of targeted online advertising.

Poor rail service persists

With containers sitting for long periods in West Coast ports and the Union Pacific receiving a regulatory order to better serve poultry processors, the need for improved rail service is an issue that has earned bipartisan support.

A topic of debate lately has been whether intermodal service will be as poor in the third quarter of this year as it was in the third quarter of last year or if service will improve in the second half. Clearly, there are now some similarities to the third quarter of last year – chassis availability is still limited, there is congestion at intermodal facilities and drayage demand remains high. But there are several reasons why congestion may turn out to be less severe: the national container fleet is growing, railroads are adding crews, and railroads are under increased regulatory pressure to improve service levels. Above all, it is unclear how well the volume will hold up given all the macroeconomic pressures that could weigh heavily on freight demand.

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