• Jeff Matthews

Where’s Inflation? Ask Del Monte

Everybody knows prices of things are rising. At least, everybody but the bond market, which appears to believe the accuracy of the inflation numbers compiled by the government and reported in various indices which, for the moment, show nothing much is going on in the world of consumer prices.

This despite the fact that pretty much every commodity coveted either by homebuilders in the United States or manufacturers in China has been on a tear the last couple of years.

Still, as Jay Fitzsimmons (who is not Wal-Mart’s CFO, as careful readers noted when I identified him thusly in last week’s post on Russia, but is, rather, Wal-Mart’s Senior Vice President of Finance and Treasurer) noted during his question-and-answer session at the William Blair conference, inflation at Wal-Mart stores is pretty tame.

Food inflation, Jay said, is running 1.8-1.9%; general merchandise deflation is about 1.3%; net-net, “there’s not much” inflation that Wal-Mart can see.

Still, anybody who eats food, drives a car, heats a house, pays rent, stays in a hotel, books a vacation, buys a newspaper and pays property taxes knows, costs of things are in fact rising.

So where are all those costs going?

To answer that question, look no further than the transcript of the recent Del Monte Foods conference call.

Del Monte does food—very basic food: canned fruits and vegetables under its own name, as well as StarKist tuna, 9-lives pet food and some other cats and dogs-type businesses.

The company was shmooshed together via a reverse merger with Heinz’s bad-for-our-P/E-Ratio StarKist tuna business a few years ago, and the ensuing equity roadshow presented a fairly compelling case of good management revitalizing long-neglected brands with strong cash flows underlying the whole smorgasbord.

Then, something happened that was not anticipated during the roadshow: costs went up and Del Monte’s earnings and stock price went down.

More specifically, according to Del Monte, it was “the rapid and unprecedented cost escalation in steel, energy and transportation-related costs, which, combined, represent about 40% of our costs of goods sold,” that hurt the company. “These increases, along with higher fish and other costs, resulted in year-over-year cost increases of over $120 million in fiscal 2005…” Del Monte did what it could to offset the cost increases by raising prices to the tune of around $90 million a year. But Del Monte’s customers did not entirely go along with that idea, so Del Monte lost market share at the likes of, well, Wal-Mart for one.

Thus, Del Monte’s operating profits in the recent quarter tanked 30%. And the pain from higher costs isn’t stopping.

“Let me just give you a range of some cost increases we’re anticipating,” the Del Monte CFO told disappointed analysts last week. “We’re anticipating packaging costs to [increase] $30 to $35 million. We’re looking at energy and logistics to [increase] $25 to $35 million. We’re looking at raw materials to [increase] $15 to $20 million.” Asked if the “raw materials” portion was just fish costs, or “a whole bunch of different stuff” by one of the analysts, the CFO responded: “That’s a whole bunch of different stuff, including fish costs.” If you’ve never heard Len Teitelbaum, the veteran Merrill Lynch food analyst, on a conference call, you should try to listen in some time. Lenny, as everyone in the world knows him (our paths crossed at Mother Merrill 20+ years ago, but he would not know me from a can of tomatoes), possesses great enthusiasm for his work and his companies, and he knows just about everything there is to know about the food industry.

But when something goes wrong, Lenny sputters—he can barely get the words out to ask the questions; and yet he will not stop until he has asked the questions and gotten the answers he wants.

And on last week’s Del Monte call, Lenny was sputtering. As is Del Monte’s own business.

Blame it on inflation—inflation for “a whole bunch of different stuff, including fish”—and Del Monte’s inability to get Wal-Mart to pass it all on.

Jeff Matthews I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

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The content contained in this blog represents only the opinions of Mr. Matthews. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. The content herein is intended solely for the entertainment of the reader, and the author.

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