Food Prices Hurting McDonald’s, but Not This Stock

By: Jared_Levy

If you have been reading Smart Investing Daily, you know that food trends, demand and subsequent food inflation have been on our radar (and trade ideas) for some time, including my Thanksgiving notes as well as my concerns here in early October.

Consumer Price Index and Inflation

When I first started in the business and was learning how the “stock market” interprets data, I was told that when market players are evaluating inflationary pressures, they pay close attention to something called the “Core CPI”; I’ll get to that in a moment, but let’s talk consumer price index first.

Consumer price index (CPI), which measures monthly prices for the goods and services we consume. It measures everything from the price of canned fish and bread to laundry detergent, fuel, electricity and even the water and sewer costs of your home; even average rent rates are measured.

The goal here is to record and monitor the costs of living in America. If we pay 5% more for the same “stuff” (on average) this year than we did last year, one could make the assumption (generally) that prices have inflated about 5%, or that our dollar may be worth 5% less (on a very basic level).

Over the past year, the consumer price index increased 1.5% and the year prior the index saw a 2.7% increase.

Core CPI -- Does It Really Tell the Right Story?

The Core CPI figure, however, strips away food and energy prices because they tend to be more volatile and may skew inflation readings. As a result, Core CPI appears as a more stable reading. Up until the year 2000, the U.S. government used Core CPI to measure the inflation rate (now they use something called the PCEPI).

My quarrel is with stripping out food and energy. Granted, they can be volatile, but if the price trend of both gets higher and higher over a long period of time, you simply cannot ignore or even discount them!

The world needs food and energy, so the two of them are a large part of our monthly expenditures. And furthermore, higher prices might just mean price increases across sectors. Let me explain.

As the world’s food demand grows, it makes sense that the average price we pay for foodstuffs will rise, which would be reflected in the consumer price index numbers. But because of those price jumps, related fertilizer and machinery companies (to harvest, refine and store) may be forced to raise prices and land values in certain areas may rise. That means higher food prices affect more than just food costs.

What if certain machine makers are re-tooling their business to cater to food-related equipment and in turn start consuming more metals and other commodities to produce that equipment and then at the same time, produce less of “other non-food equipment”? For example, what if Caterpillar (CAT:NYSE) stopped making mining equipment and started only making commercial farm tractors? That may create higher costs of mining machines, because higher demand for food-related machinery and a supply reduction for non-food machines forces higher prices to trickle down and spread to other industries. That means other companies will raise prices just to keep up. And the upward pressure makes it harder to lower prices quickly, causing inflation across the other components of the CPI. Energy costs can have similar effects.

I have to disclose that I am not a trained economist, but it doesn’t take a rocket scientist to look around and make these connections, and frankly, if you have read my past commentary, I have been able to profit from my thesis.

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Rising Costs for Producers Means Consumer Price Increases

According to RBC Capital Markets analyst Larry Miller, McDonald's (MCD:NYSE) will raise prices 2-3% in 2011 to offset inflation and increases in food costs. For the world’s largest fast food chain, which has the ability to control its input costs to an extent because of its intricate network of food producers and suppliers, this is a major move.

Its control can only go so far and it has lost some of it apparently.

McDonald’s has such far-reaching penetration in global food consumption and pricing that the Economist magazine even has a "Big Mac Index," which compares the Big Mac's cost in various world currencies. This index can informally judge a country’s purchasing power parity. (Iceland currently has the most expensive Big Mac at $7.61 USD as of October 2010.)

The bottom line is that the move by McDonald’s tells me that it believes higher costs are here to stay and we may see even more upward pressure. And with 58 million customers served daily, I think the company has a good reading on the global food pulse.

How Do You Play It?

First off, I don’t think it’s time to buy MCD; rather let’s stay focused on the folks that seed, fertilize and farm the crops that are turned directly into what we eat or used to feed the meat and poultry that may also end up on your plate.

The Mosaic Company (MOS:NYSE) piques my interest; I think the recent sell-off down to $75 makes this stock attractive. Even though the recent spinoff from Cargill may seem like the farming cooperative was calling a top in the industry, there are many nuances to the deal that I think many just got wrong.

Cargill is a mostly family-owned private company and will actually be swapping out most of its holdings in MOS in exchange for privately held shares in Cargill that are currently held in trusts. The balance will be used to pay down debt and keep Cargill private. Cargill can now get back to its core business and let the volatile stock of Mosaic grow on its own.

Mosaic was actually created in 2004 from the merger of Cargill’s crop nutrition unit with IMC Global, which is where the large holdings came from.

In 2009, rumors were swirling about Cargill actually buying MOS, but in reality, MOS is a stock that will now be wholly owned, which may actually make it an even more attractive takeover candidate.

The world’s hunger will continue to grow and the Mosaic Company (along with others) will help feed it.

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Source : http://www.taipanpublishinggroup.com/tpg/smart-investing-daily/smart-investing-012511.html

By Jared Levy
http://www.taipanpublishinggroup.com/

Jared Levy is Co-Editor of Smart Investing Daily, a free e-letter dedicated to guiding investors through the world of finance in order to make smart investing decisions. His passion is teaching the public how to successfully trade and invest while keeping risk low.

Jared has spent the past 15 years of his career in the finance and options industry, working as a retail money manager, a floor specialist for Fortune 1000 companies, and most recently a senior derivatives strategist. He was one of the Philadelphia Stock Exchange's youngest-ever members to become a market maker on three major U.S. exchanges.

He has been featured in several industry publications and won an Emmy for his daily video "Trader Cast." Jared serves as a CNBC Fast Money contributor and has appeared on Bloomberg, Fox Business, CNN Radio, Wall Street Journal radio and is regularly quoted by Reuters, The Wall Street Journal and Yahoo! Finance, among other publications.

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