COMPETITION SEEN LIMITING RETAIL PRICE INCREASES

MARK HAMSTRA

NEW YORK -- The current deflationary direction of wholesale food prices may be easing, as is shown by recent price increases from manufacturers, but competitive pressures may limit retailers' ability to boost price points, trade observers told SN last week.

And, some predict, increased prices, coupled with a limited ability to pass them on, may prompt retailers to endeavor to increase their private-label market share in high-velocity categories such as coffee, cookies and crackers.

In the past two weeks, two major consumer packaged goods manufacturers said they planned to raise prices starting at the end of this month, and others are expected to follow suit as this year's drought conditions limited grain harvests and drove up ingredient costs.

At the opposite spectrum, higher feed costs and other factors also forced beef and cattle producers to cull their herds, driving down wholesale prices, while wholesale poultry prices also experienced some deflation because of international pressures. All are expected to rebound next year.

Produce prices also have been held back recently because of strong West Coast crop harvests, and dairy prices have been driven down by oversupply due to increased production capacity, analysts said.

The lack of inflation this year on packaged goods and the deflationary pressure of meat, dairy and produce prices have helped depress retailers' same-store sales growth, according to several retailers and analysts. Carteret, N.J.-based Pathmark Stores recently said that deflation in meat and dairy prices contributed more than half of a percentage point to third-quarter same-store sales declines of 2.6%.

"Our business is being affected by deflation, particularly in dairy and dairy byproducts and meat products like poultry and pork," said Eileen Scott, chief executive officer, Pathmark, in a conference call discussing third-quarter earnings.

Other retailers have reported similar effects of wholesale price deflation as they have been forced to sacrifice margins in a difficult economy and amid pressure from competitors like Wal-Mart Stores, Bentonville, Ark.

"It has been tempting to pass along lower prices from meat and produce items and promote those items and make them great buys for consumers," said Jason Whitmer, analyst, Midwest Research, Cleveland.

He said the "real culprit" in same-store sales weakness, insofar as it is affected by prices, is the lack of inflation in packaged goods, which typically rises between 1% to 2% per year but has been flat this year. He predicts inflation in some items of about 3% to 4% next year.

Although wholesale price inflation traditionally would allow retailers to raise their prices to consumers, supermarkets could meet some resistance, other analysts said.

"On the wholesale side there's going to be inflation, but there's no indication that it's going to be passed through," said Andrew Wolfe, analyst, BB&T Capital Markets, Richmond, Va. "That's a function of the competitive environment."

Wolfe, who follows supermarket companies in the Southeast as well as pork producer Smithfield Foods, Smithfield, Va., said retailers might have to absorb some of the wholesale price increases of meat, but he expects retail CPG prices to rise next year along with wholesale prices.

Pork has been among the hardest hit of the commodities this year, with wholesale prices down as much as 30% from year-ago levels in September.

"You had a confluence of factors that created an excess supply, and that should pretty much completely reverse itself next year," he said.

He said producers expect beef supplies to be down about 4% to 5% next year, pork to be down 2% to 3% and chicken to be down about 1%, which should increase wholesale prices.

Meredith Adler, analyst, Lehman Bros., New York, said history following recent droughts indicates that meat prices don't always rebound right away, however.

"In 1998, the drought was really severe, and you did get deflation in meat prices, but you didn't get inflation the following year," said Adler. "Then in 2000 and 2001, you had a lot of inflation in meat, so there would seem to be a lag effect."

In packaged goods, Kraft Foods, Northfield, Ill., and Kellogg, Battle Creek Mich., said they planned to raise prices on certain products at the beginning of next year.

Christine McCracken, a consumer products analyst in the Manhattan Beach, Calif., office of Midwest Research, said she thinks the companies will target the price increases to those products likely to meet the least consumer resistance.

"It will be very selective," she said. "There's been a lot of competitive pressure in some categories, but maybe they don't have the same competitive pressure in high-velocity items like cookies and crackers."

With private label's large share of the market in the cookies and crackers categories, retail price increases on branded items could give retailer's store brands a boost, according to McCracken.

"I guess the biggest question is whether or not the price differential will be passed through in private label, or if this will give private label an opportunity to gain market share," she said.

Wal-Mart's reaction could also play a role, she said.

"All boats could rise on this, if Wal-Mart increases its prices," she said.