Last month, I showed how investors can generate investment ideas by using the producer price index (PPI) report prepared monthly by the Bureau of Labor Statistics. The idea is that industries in which prices are rising may contain companies whose revenue will grow faster or whose margins will improve.
Of course, like any initial screen, the PPI report is only a starting point. It is useful to generate ideas, but further research is needed to determine whether they are good ideas. This month, I do some of that further research.
The first industry I mentioned last month was fruit and vegetable canning. Year-over-year price increases for the industry have been well above average, and although they have come down a bit from a peak earlier this year, the upward trend still appears to be in place; inflation ticked up to 5.5% last month from 5.3% in August.
As I noted last month, possible plays on this industry include packaging companies (can makers) such as Ball Corp.
(BLL)
, Crown Holdings
(CCK)
or Silgan
(SLGN)
. Or you can go to the food processors such as Campbell Soup
(CPB)
, Del Monte
(DLM)
, Hain Celestial
(HAIN)
or H.J. Heinz
(HNZ)
.
Year-Over-Year Price Increases in the Canning Industry
Source: Bureau of Labor Statistics
Let's start with Ball. When Ball released second-quarter results, it said it would increase capital spending "related in part to 2008 capacity additions for Europe, where we are essentially sold out this year and next." President and CEO R. David Hoover called the first six months of 2007 the best half-year in Ball Corp.'s 127-year history in terms of sales and earnings. The strong first half supports the initial PPI reading, and the continued strength in pricing power suggests more good news to come.
However, Crown Holdings noted in its earnings report that raw materials prices were also rising. Passing through cost increases helps sales growth, but may not benefit profit margins. Crown may be more exposed than others in the industry, suggesting greater caution on the name and an eye on raw material costs if any investments are made.
Silgan also commented on raw material costs, but reports that the pass-through works on a lag. "Operating margin increased to 7.6% from 5.4%
[due in part to]
the lagged contractual pass-through beginning in the latter part of 2006 of significant inflation in other manufacturing costs." Silgan looks like a good bet, as the lag effect will mitigate the impact of future cost increases and also help margins even more the next time raw materials prices head south
Moving to the food processors, Campbell's Soup said, "Gross margin increased to 41.9% from 41.8% ... primarily due to productivity gains and higher selling prices, partially offset by cost inflation." Rising prices also contributed 2 percentage points of the 7% total sales growth for the year. With the stock not yet reflecting these results, investors may want to take a good look.
For Del Monte, however, the rising prices are hurting more than they are helping. "The company now expects fiscal 2008 diluted EPS from continuing operations to be at the low end of its previous guidance of $0.70 to $0.74" due primarily to cost increases in excess of what it can pass through. Given the better apparent prospects from other names that passed the screen, it is hard to argue in favor of Del Monte.
No so for Hain, which reported "gross margin of 27.9% in the fourth quarter, compared to 26.5% in the prior-year fourth quarter. For the full year, gross margin was 29.0% compared to 28.9% for the prior year. Margin improvements achieved through productivity gains and price increases were offset by the challenges at Celestial Seasonings." Hain has had a good year, though, suggesting that investors may have already picked up on the positive news.
Finally, Heinz increased its sales and earnings guidance, saying on the conference call that it is "seeing positive net pricing and productivity offset these cost headwinds."
The initial positive read from the PPI report seems to be confirmed in five out of seven cases. In a few of the cases (Ball, Silgan and Hain) the stock price has followed the pricing trends, which bode well for continued strong performance. For Campbell's and Heinz, the stocks have been stuck in neutral, and (pardon the pun) may be ready for one of Cramer's "ketchup" plays.
At the time of publication, Trent had no positions in the stocks mentioned, although positions may change at any time.William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.
