Markets & Finance

The Lowdown on Higher Prices


With energy and labor expenses climbing, companies are passing along costs to consumers. Here's how players in key industries are handling the hikes

From Standard & Poor's Equity ResearchManufacturers and retailers of food items and many household goods, from pizzas and styrofoam peanuts to lattes and laundry detergent, are raising their prices to cope with the incessant rise in the cost of oil and now in the cost of labor and agricultural goods such as corn and soybeans.

While no company is able to completely escape the effects of rising energy and labor prices, how each responds may affect its competitive position for years to come, and companies that are highly leveraged could be weakened far more than those with stronger balance sheets.

Pizza delivery chain Domino's (DPZ; $19; 3 STARS, hold) is pushing through a price hike to keep up with the soaring cost of cheese, as pricier feed sends milk prices close to a record high. At the same time, wages and electricity and gasoline costs are going up. "We are currently experiencing a challenging cost environment with labor, commodity, and energy prices all rising in unison," David Brandon, the chain's chief executive officer, told investors last week in announcing second-quarter earnings. "We believe these conditions will lead to a material price increase in the pizza category."

Slices of the Pie

That may spell some trouble for Domino's, says Standard & Poor's equity analyst Mark Basham. Rival Pizza Hut, owned by Yum Brands (YUM; $32; 3 STARS), has announced only a modest price increase for its cheese pizzas and will probably be able to get by mostly by cutting down on promotional discounts. "Contrast that to Domino's CEO's comment that he sees no other way to restore margins at the store level than to significantly increase prices," says Basham. "I think there will be some market-share shifting between Pizza Hut and Domino's, along with the third big pizza operator, Papa John's (PZZA), as they adjust their prices and promotion strategies."

Oil prices have risen steadily for the past five years and are now at record highs, while natural gas prices are triple what they were in 2002. More expensive oil has led to a huge increase in demand for corn to produce ethanol, which in turn raises prices for other feed crops such as wheat and soybeans and eventually puts upward pressure on meat, dairy, and poultry costs. Rising oil prices also boost the cost of packing and of chemicals used to make items such as soap. Meanwhile, labor prices are rising and will likely keep going up as new minimum wage levels take effect.

Higher milk prices are even taking a toll on coffee retailer Starbucks (SBUX; $27; 4 STARS), which last week announced its second price hike in less than a year to cover the added expense, as well as costlier energy and coffee. Packaged food maker Kraft Foods (KFT; $33; 3 STARS) is coping with rising cheese prices. Like Starbucks, the company announced a second price increase in 12 months for cheese products, totaling between 5% and 12%, and says it plans to introduce several products and promotional campaigns to win back its recently lost market share. During the second half of 2007, "we look for price hikes to at least partly offset commodity cost pressure," says Standard & Poor's equity analyst Tom Graves.

High Demand Helps Some

Beverage makers generally are faring better than other food companies. Brewer Anheuser-Busch (BUD; $50; 4 STARS) plans to push through a price increase on some of its products later in 2007 and others in early 2008. Barley has gone up along with wheat and corn, while the costs of cans has been soaring because of rising aluminum prices. But beer consumption is unusually strong this year, says Standard & Poor's equity analyst Raymond Mathis, giving the company and its rivals room to raise prices. "I don't think it changes the company's competitive position. All its competitors are trying to pass through rising input costs as well." While beer makers have been known to engage in price wars, he says, rising sales volumes mean that higher prices will lead to wider profit margins.

Agribusiness companies have less leeway to raise prices since the prices of their commodity products are highly dependent on supply and demand conditions, says Standard & Poor's equity analyst Joseph Agnese. Nevertheless, many are coping fairly well with rising feed costs. Beef producers are benefiting from strong domestic and international demand, which has allowed them to hike prices more than their costs have increased, while reduced capacity in the poultry industry have given companies pricing power.

Producers of such products as high fructose corn syrup, a key ingredient for soft drinks and a wide range of processed foods, are also able to offset corn's rising cost—which hit a 10-year high in February—because they are operating at or near full capacity. "Since demand is high compared to supply, these companies have had an easier time passing along any cost increases," Agnese says.

Scully is a reporter for Standard Poor's Editorial Operations.

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