Australia | Oct 04 2007
By Chris Shaw
While yesterday’s retail trade data will require the Reserve Bank of Australia (RBA) to keep a close watch on the broader economy there is little doubt from RBA statements the major point of its policy focus remains inflation.
Commonwealth Bank chief economist Michael Blythe is one of the more optimistic on the inflation outlook as he expects faster growth in both capital stock and labour supply to lift the economy’s potential growth rate, means an expansion on the supply side will take the sting out of the inflationary pressures currently being experienced in Australia.
Blythe notes there are two exceptions though, these being the housing sector and food costs. Housing prices are likely to be forced higher thanks to a current mismatch between demand and supply that is increasingly tightening the market, but the issues in terms of food prices appear more structural in his view.
First, as the world’s population continues to expand demand has increased accordingly, particularly in the Asian region as the wealth effects of the stronger Chinese and Indian economies flow through to their immense populations.
As Blythe notes it is at lower income levels where there is the largest increase in food consumption, so it is no surprise demand is increasing significantly. Bad weather has also played a role as crop yields are at times struggling given poor conditions, with this year’s wheat crop in Australia a prime example.
The other element contributing to food prices being pushed higher is the emergence of biofuels as an energy source as this is causing some crops such as corn and sugar to be diverted to uses other than food, leaving less left over for people to eat.
This has changed the dynamics of the global food market, as Blythe points out since 2002 food prices have risen on average by 6.3% a year, compared to average annual falls of 2.0% from 1980-2001.
It is inevitable this has some CPI impact in Australia, Blythe noting over the past two years the bank’s measure of grain prices is up 112% relative to this time two years ago.
Factoring this into the outlook for the next two years sees Blythe estimate the grain-affected components of CPI will increase by around 18%, which translates into a 0.7% CPI increase in the CPI.
UBS agrees food inflation is trending higher, particularly given pressures in the wheat, meat and milk markets. The impact on companies operating in the sector is different depending on their position, the broker pointing out food retailers should do well while food suppliers are likely to struggle.
The reason is food retailers such as Woolworths (WOW) and Coles (CGJ) can, if they adopt rational pricing, better recover their cost increases, particularly in the case of the two companies mentioned given their strong market positions.
The food suppliers however will have a fight on their hands to maintain margins as higher prices can force customers to trade down in terms of brand as they attempt to offset the increases.
The most at risk here in the broker’s view appears to be Goodman Fielder (GFF), as on its numbers the company needs a 5% increase in bread prices and a 10% increase in milk prices simply to maintain its EBITDA in FY08. Also at some sort of risk in its view is Coca-Cola Amatil (CCL), as via its ownership of SPC there is scope for some cost pressures to impact.
The broker rates both stocks as Neutral, while the FNArena database shows Goodman Fielder scoring three Buys, two Holds and two Sells overall and Coca-Cola Buy five times, Hold three times and Sell once.
UBS rates Woolworths as a Buy, the FNArena database scoring it Buy four times, Hold four times and Sell once.
