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Best U.S. food stocks to hold amid rising commodity prices Add to ...

The iPath Dow Jones - UBS Commodity Index has jumped 17 per cent over the last six months, and this speedy ascension has investors pondering the impact on food companies.

When prices jumped in 2008, several food companies just passed along the increases to customers. The recession was just in its preliminary stages back then so the higher prices were more easily accepted by consumers. Now, however, with U.S. unemployment continuing to hover near 10 per cent, those same consumers may hesitate to pay up for their favourite brand.

Food companies have already suggested they may wait two quarters before passing on the increase, which will cause margin compression in the meantime. Major companies have already missed earnings and some have lowered guidance. Credit Suisse analyst Robert Moskow reviewed several food companies and their sensitivity to commodity inflation and found some names were better equipped to deal with the cost increases than others.

Moskow believes that The Hershey Company has the best opportunity to weather commodity inflation because of volume growth and pricing.

The company did warn that ingredient costs will be higher for 2011 though as sugar prices have risen because of weather-related production problems in Brazil. However, India has had a great growing season and now sugar prices may drop again as this new player enters the market.

TheStreet Ratings gives the stock a "buy" rating. Hershey's gross profit margin increased in the third quarter of 2010 over the year before, and the company also grew its sales and net income during the past quarter when compared to the previous year and net income outpaced the industry average.

TheStreet Ratings notes that Hershey trades at a significant discount to its peers on a price-to-earnings basis. Hershey's has two new products coming in December, Hershey's Drops and Reese's Mini's

Kraft Foods Inc. gets an "outperform" rating from Moskow. He thinks the stock is unloved and that any bad news is already baked into its share price.

The company recently noted it's lifted pricing on 40 per cent of its portfolio in Europe and that it expects to boost pricing in its Nabisco category as well. While its competitors haven't raised prices yet, Kraft believes they will soon follow. Kraft has positioned itself well in Wal-Mart Stores Inc. and Kroger, even though it lost its Starbucks partnership.

Institutional investors are underweight the stock and it trades at a 5 per cent discount to the food group. TheStreet Ratings has a "buy" rating on Kraft as well, citing the trading discount.

Sara Lee Corp. has already raised prices in meat and beverage and it did not see any volume declines.

Spot inflation for the company's ingredients is up 21 per cent, when just three months ago it was up 15 per cent. In the last quarter, commodity inflation cost the company $90-million (U.S.), but that was partially offset by $28-million in pricing increases. Moskow raised his 12-month price target on the stock to $17 in November, even though he maintains a "neutral" rating.

TheStreet Ratings gives the stock a "buy" rating, noting that Sara Lee is expected to have an earnings growth rate that significantly exceeds its peers.

On a price-to-sales ratio basis, the stock is trading at a discount to the industry. Looking ahead, there are signs the company may make a run at adding a coffee brand to its portfolio, such as Maxwell House or possible a Brazilian name.

H. J. Heinz Company expects tomato and potato costs to become more favourable in quarters to come. This should offset the higher prices for packaging and sugar.

The company reported a 5-per-cent increase in the first quarter for dairy costs, but managed to offset that through contract pricing. Heinz says it dealt with 3 per cent inflation for 2010, but only expects inflation of 0 per cent-1 per cent for 2011.

Moskow writes: "Heinz has limited exposure to commodity inflation and currency." He also noted that October vegetables had the sharpest PPI deflation of the food group.

TheStreet Ratings give the stock a "buy" rating, noting that its current price-to-earnings ratio indicates a discount to the food products industry. Argus Research analyst Erin Smith also believes the stock is undervalued and has a 12-month price target of $55 and a buy rating on the shares.

ConAgra Foods looks to be in the worst position to pass through price increases as its categories are among the most competitive in the industry.

Moskow expects a shock to ConAgra's volume sales when they push through the higher prices, a similar situation that occurred in 2008. The company is already hedged by about 40 per cent on its 2011 commodity calendar, so Moskow isn't too worried about 2011, but he is concerned about the beginning of fiscal year 2012.

He thinks investors should stay away from ConAgra, saying it will be "extremely challenging to improve margins amid current conditions." TheStreet Ratings warns that sales and net income are underperforming its competitors, and says ConAgra is expected to significantly trail its peers on the basis of its earnings growth rate.

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