By Matt Andrejczak
A plunge in commodity prices late last year is causing havoc
among first-quarter corporate earnings this month, as many
companies find themselves caught on the wrong side of their
financial programs to hedge against volatile moves in oil, corn and
grain prices.
Moves to lock in prices when commodities were soaring last
summer have now backfired after the prices suddenly plunged in the
final months of the year, pinching companies from airlines to food
makers to oil providers. At the same time, companies that avoided
locking in future commodity prices should stand to benefit.
"It's a sophisticated business that not everyone is good at,"
said John Langston, senior analyst at Dallas-based Hodges Capital
Management. "Even the best hedgers could get hurt."
This week, the parent companies of United Airlines and American
Airlines reported hedging losses on bets they made on jet fuel,
which has collapsed in price the past six months. Delta Air Lines,
which reports earnings Jan. 27, could very well be blasted by the
same headwind.
Even Southwest Airlines, well-known for successful bets on oil
prices, took a $117 million charge in the fourth-quarter related to
its fuel hedges. The low-fare carrier further unwound most of its
fuel hedges extending out to 2013.
Elsewhere, meats producer Tyson Foods Inc. (TSN) on Monday is
expected to take a hefty write down on its feed-grain hedges, with
one analyst predicting the write-down could be as large as $100
million. And the decline in agricultural commodity prices may also
affect hedging programs at other food makers, as General Mills
proved last month.
While the plunge in commodities is a much-welcomed relief for
companies who struggled to cope when prices blasted to record highs
last July, the eye-popping price drop in the commodities basket
does put pressure on corporate balance sheets.
Soured hedges could force companies to record them in their
operating segment earnings, prompting mark downs or write offs -
moves that shave profits and squeeze cash from operations. Many
food companies, for instance, consider hedges an "unallocated
corporate expense" until a contract is closed. The gain or loss is
then recorded on the profit line.
To Hedge Or Not To Hedge
Companies use hedges to protect themselves against volatile
swings in commodity prices, smoothing out some of the peaks and
valleys in the commodities market by managing risk through futures
and options buying. But when prices sink or skyrocket over a short
period of time, not all corporate hedging programs will come out
above water.
Pilgrim's Pride (PPC) got swept aside by the commodities
rollercoaster. The No. 1 U.S. chicken producer went bankrupt a
month ago, in part on bad corn bets.
Smithfield Foods (SFD) said "long grain positions through our
hedging program" would likely make its hog production division
unprofitable until this spring. This is in spite of declining hog
raising costs.
Airlines have shown wrong-sided hedges take a toll on free cash
flow - or money that's left over each quarter after all necessary
expenses are paid.
United's (UAUA) hedging strategy cost it $936 million in total
recorded losses for the quarter ended Dec. 31, putting its free
cash flow at negative $1.1 billion.
American (AMR) had to post $575 million in cash collateral with
fuel hedge counterparties. And Delta (DAL) has said it could post
$1.1 billion in cash collateral. On the flip side, declining oil
prices will help the airlines.
A much-weaker price for crude, once close to a $150 a barrel and
now around $40, is spoiling profits at ConocoPhillips (COP) and
Chevron Corp. (CVX).
Conoco, the No. 3 U.S. oil provider, said Jan. 16 it plans to
write down the value of its existing oil reserves and operations by
$33 billion, after tax. The non-cash mark down includes a $7.3
billion write-down of its stake in Russian oil company Lukoil.
Chevron, No. 2 U.S. company, warned Jan. 8 its fourth-quarter
earnings were shaping up to be "significantly lower" than the third
quarter.
General Mills, the top performing food-maker stock in 2008,
illustrates what a hedging program can cost. The cereal maker "may
find itself over-hedged in a falling commodity world," analyst
Jonathan Feeney of Janney Montgomery Scott said in a recent
research note.
For the quarter ended Nov. 23, General Mills (GIS) marked down
$269 million on certain commodity hedges and grain inventories,
subtracting 49 cents from its earnings.
Because the hedging losses are non-cash, paper losses that are
one-time in nature, "We are not concerned by these losses, and we
believe the market looks past these losses and focuses more on the
results of the underlying business," said Edward Jones food analyst
Matt Arnold.
Kraft Foods (KFT) will be another one to watch when it reports
earnings Feb. 4. The No. 1 U.S. food maker highlighted in its
October report that its earnings-per-share growth was somewhat
blunted by a $140 million hedging losses, offsetting the earlier
benefits of some restructuring moves.
While there is no question companies should benefit this year
from the commodity-bubble burst, companies that didn't employ
advanced hedging programs should get a real nice tailwind.
Poultry producer Sanderson Farms (SAFM) doesn't hedge it corn
costs, nor does egg producer Cal-Main Foods (CALM), while fruit
supplier Fresh Del Monte (FDP) buys its bunker fuel at spot market
prices.
Panera Bread (PNRA) has made its bet on wheat prices, locking in
its total 2009 wheat needs for a price of $9.50 a bushel, vs.
prices earlier last year of $13 or $14. March wheat futures are
trading around $5.66. The retailer does not purchase options or
futures, but instead enters contracts with wheat mill operators to
purchase wheat at a planned price, spokesperson Linn Parrish
said.
Analyst Jeff Farmer of Jefferies & Co. calculates that this
will pad the baker's earnings by 32 cents a share this year, making
wheat-cost savings the biggest profit driver for Panera.
-By Matt Andrejczak; 415-439-6400; AskNewswires@dowjones.com
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