The FINANCIAL — Fitch Ratings-London-16 May 2011: Fitch Ratings says in a new report that commoditised or primarily western Europe-exposed food producers and value-clothing retailers are the most vulnerable among EMEA corporate sectors to rising agricultural commodities.
This is because of their medium exposure to input cost changes and more limited space of manoeuvre to absorb or pass through higher costs in a timely manner. These sub-sectors are pressured by their high competitive environment, limited product differentiation, or specific customer groups who are not used to price rises.
"Consumers in mature markets, in particular many European countries, including the UK, are overwhelmed by rising taxes and fuel and energy bills and high unemployment rates and debt levels," says Giulio Lombardi, Senior Director in Fitch's EMEA Retail and Consumer Products group. "These pressures could mean that certain food producers or apparel retailers with weak brand equity and predominantly Western European operations will struggle to pass through rising costs of goods sold as their customers are reluctant to pay higher prices for their food and clothes. In the long term, this could have adverse effects on those companies' ratings."
Commodity traders, such as Archer Daniel Midland ('A'/Stable), are also characterised by high exposure to commodity price increases. However, the effects are mitigated by the superior ability of global traders to react to challenges by passing on the increase. However, this is subject to the maintenance of ample liquidity back-up lines and the willingness of banks to lend against the inflating value of the traders' readily marketable inventories.
Amongst the least affected by rising agricultural commodities are global brewers, global branded-food processors with presence across different pricing points and geographies food retailers, and mid-market clothing retailers, such as Next plc and Marks & Spencer Group plc (both 'BBB'/Stable). These sectors have low to medium exposure to commodities, and can largely offset price changes due to the combined effects of costs cutting, and a moderate elasticity of demand to price rises, which allows some cost pass through.
The report, entitled Rating Impact of Agricultural Commodity Inflation is the second in a series of three reports that assess the EMEA Corporate Sector's exposures to oil and gas prices, iron ore and agricultural commodities.
The reports analyse the characteristics of each industry sector and the impact of the previous period of high raw material price increases (i.e. 2005-2008) on the performance of more than 20 issuers to draw conclusions on the various sectors relative ability to cope with cost inflation. A fundamental difference between that period and recent developments is that in 2005-2008, demand for end products was generally high across markets, whereas Fitch's central scenario considered in these studies is for continuously high raw material prices due to supply shocks and/or high demand from emerging markets with demand for end-products remaining subdued in most developed markets.
In most cases, Fitch concludes that for raw material users of oil and gas, iron ore and agricultural commodities, the rating impact of prolonged raw material inflation is expected to be modest with geographically diversified companies with strongly differentiated products in a better position to pass on increased costs. Besides airlines, other vulnerable sectors identified are commoditised foods producers, commodity steelmakers, chemical companies, mass-market auto manufacturers and value clothing retailers, especially those with a predominantly western European exposure.
Source: Fitch ratings