$100 oil risks reigniting food inflation

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SIMON BROWN: I’m chatting now with Keith McLachlan of Element Investment Managers. Keith, appreciate the early morning. I mentioned when I was chatting with Nick [Kunze??] that the Barclays estimates are that a 10% sustained rise in crude oil adds 0.2% to inflation. That, of course, is in US [dollars].

But the short answer is we’re going to see it coming through. We’re going to have horror petrol and diesel price increases at the end of the month.

Looking at food retailers versus food producers, inflation hits them differently in terms of how they manage it.

KEITH MCLACHLAN: Good morning, Simon. Absolutely – if we went back a week or two, this discussion would be quite different because, if you have a look at the soft commodity basket with certain exceptions, like meat prices in South Africa because of foot and mouth, and there are one or two other ones – generally speaking the soft-commodity basket is down on a 12-month rolling basis, and we’re seeing generally lower food inflation.

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I just attended an agricultural summit, and all of the agricultural economists were looking forward, and they’re all talking about soft commodity deflation effectively very gentle and coming down. And if the oil price remains at over $100/barrel, that is very wrong. I mean, if we look at the oil-price inputs into food production, it’s about 15-20% of the cost of food production. But that’s only the direct cost.

The indirect cost stacks up to about 40-50% because, think about it, farms aren’t very often next door to you, so the food has to move. The retailers have vast networks – that means going to move again. And then you’ve got to move and get to the store. The stores are going to come to you via Checkers Sixty60. The point is that everything that moves in the economy uses energy, and a large amount of that energy is oil.

So the longer this price remains sustained at these levels in terms of oil markets in the Middle Eastern conflict, the more the odds are that everything shifts towards inflationary trajectories, as opposed to the opposite. So it starts to become a very different argument.

Then the question is: Who does better in an inflationary environment? Food producers, retailers – or do we just avoid them all?

SIMON BROWN: [Chuckling] The question is, I suppose, who can pass on that that increase? The increases are coming; the cost pressures are coming. It’s their ability to pass it on. Do we have any sort of insight? We’ve seen inflationary pressures before. Who manages better with passing on increases?

KEITH McLACHLAN: Well, certainly I think we need to separate the food producers into those that have strong brands and those that offer commoditised products. The commoditised products will pass on the costs, but they’ll have to compete with the rest. And the oil price shock really kind of operates effectively the same as the interest-rate hike, where it collapses the disposable income of the consumer.

So the commoditised ones will probably be all right, but they won’t do spectacularly. The branded ones will be able to pull the price lever a lot quicker. and it’s like a rocket taking off. And if the oil price comes back down, don’t expect those price decreases to happen as fast. So margins remain open longer.

But then shifting to the retailers, don’t forget the retailers now – most retail models have shifted to DCs [distribution centres] and centralised logistics. So they start to carry a little bit more of the logistical cost and in moments like this that becomes a problem because that costs a lot more.

And then second of all, you have to separate between high-end, let’s call it, grocery retailers and low-end gross retailers; and then you’ve got the discretionary. So first of all, the discretionaries get heavily impacted – the Truworths, the Foschinis. If people want to buy food or clothing they tend to buy food.

But then, with high-end versus low-end, it tends to be a trading-down effect. So [guys] like Woolies struggle to pass on those costs, because their footfall drops and people start to trade down into Shoprite – and even now we have Boxer listed. So it all depends how long this oil-price shock remains, and that means how long it [takes to] build into everyone’s budgets and we start to change our consumer decisions.

But, broadly speaking, you want to be in well-branded food producers on the staple side, and possibly low-end retailers on the staple side as well. You want to avoid discretionary and you want to avoid commodity.

SIMON BROWN: I take your point, 100% – how long. The hit here is going to be the petrol price. That is going to happen in the first week of April. My back-of-an-envelope [estimate] says we’re going to have petrol close to R30, maybe R28 or thereabout a litre from what, the low R20s, R20-odd. We’ve a bit of a breathing room for three weeks. But if it’s still going on to that point where we’re in for a heap of pain.

KEITH McLACHLAN: Definitely, definitely. And it also shifts footfall patterns. I ordered some Checkers Sixty60 over the weekend. It has been a while since I did that; their delivery fees are up to R36. I remember when they were free and then they hiked them to R30. That’s actually a 20% hike to R36. How many people [will be] using Checkers Sixty60 at R100 delivery fees?

Also consider that big-box retailers tend not to be convenience retailers, but convenience retailers tend to be closer to you. So if you’re suddenly making resource decisions on how far to drive your car to go to your shop, the convenience guys start to win, so it shifts all these purchase decisions around. But it does take a while to turn up in household budgets.

We do have a staggered oil price because it is regulated. Well – the fuel price in South Africa. But there is going to be a large hike coming because, don’t forget, we get the double whammy of oil spiking, and the rand is a risk-on currency. And therefore the rand weakens in these moments as people seek safe havens elsewhere.

So there’s the double impact of that. Once again, it all comes down to how long this lasts, how long it drags on – and therefore how much does it cost us all.

SIMON BROWN: It’s a triple whammy because of the fuel levy for the Road Accident Fund – well, I think that’s only 20 odd cents.

But I like your point. We travel. At R28 a litre of petrol we just simply travel it.

We’ll leave it there. Keith Mclachlan, Element Investment Managers, I appreciate the early morning.

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