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  • commodity risk
  • consumer goods
  • Hedging
  • Risk management

P&G defends no-hedging policy, insists customers will pay for $2.3bn commodity hit

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The consumer giant’s pain comes as US food companies added $1.37bn of commodity hedges in Q3, helping them to stave off inflation.

by Anmol Karwal

Published: 9 November 2021

After betting that it didn’t need to hedge against commodity prices, household products multinational Procter & Gamble has been stung by a $2.3 billion increase in raw material, freight and FX costs for its current fiscal year, according to the firm’s third quarter results announcement.

Responding to criticisms of its no-hedging strategy, the company insists that pricing, sourcing efficiencies and natural hedging within its diverse portfolio will recuperate the current losses. This comes at a time when successful hedging outcomes at other consumer goods giants help abate input cost spikes in the short term.

Mounting Pressure

P&G is experiencing worse-than-expected commodity inflation across its operations. The company had previously surprised its investors with a $1.8 billion headwind from commodity costs months after stating that the impact of raw material price increases would be neutral.

In the Q3 earnings announcement, the company said that it had underestimated the hit by $500 million, as now anticipates the impact of materials, freight and FX to be at $2.3 billion, out of which $2.1 billion will be from commodities based on current spot prices which it assumes to sustain going forward.

“We have significant exposures to certain commodities, in particular certain oil-derived materials like resins and paper-based materials like pulp, and volatility in the market price of these commodity input materials has a direct impact on our costs”, the company said in its third quarter filings.

Surging raw material prices have been a challenge for consumer goods companies operating a commodity intensive business. As they spend more than a third of their revenue on input costs, a stringent commodity risk management policy is essential to reduce volatility in financials. The rise in commodities resulted in most companies revising their inflation forecast in the last quarter, as previously reported by EuroFinance.

However, P&G doesn’t hold any financial derivatives to hedge its future raw material consumption. Derivative instruments like futures, forwards and options are used to hedge the price movement of the underlying asset to help prevent losses from unfavourable price changes.

Instead, the company expects consumers to pay higher prices, offsetting some of that with productivity and innovation programmes as well as what it describes as natural hedging positions to counter inflationary headwinds.

“That's [Natural hedging] the best way for us to protect against volatility and the most cost effective way to protect against volatility” said Andre Schulten, CFO at P&G on a call with analysts.

The CFO batted away suggestions that the strategy had failed to deliver.

“While we experienced the full impact of rising commodity and transportation costs in the first quarter of FY’22, at the same time healthy top-line growth of 5% and strong cost savings kept EPS growth nearly in line with prior year” Schulten continued.

However, P&G’s divergent approach wasn’t able to provide any relief in the short term as gross margins deteriorated by 350 basis points, or $349 million because of commodity cost increases in the third quarter, higher than the 220 basis points hit in the previous quarter.

Hedging benefits

By contrast, food and drinks manufacturers are keen users of commodity hedging, partly because their raw materials are easier to hedge. The US beverage giant, Coca Cola which had almost doubled its notional commodity hedges throughout 2021 reaped gains as it locked raw material prices at lower levels.

“We continue to see a minimal commodity impact due to hedges we have in place for the remainder of the year.” said John Murphy, CFO at Coca Cola during a 27th October earnings call.

The company held notional derivatives worth $1,024 million at the end of the third quarter; $213 million lower than last quarter as hedges began to expire. Despite that, the current amount is sufficient to cover almost 6.5% of its goods sold. Anticipating its hedges to roll off in 2022, the company says it employed revenue growth management capabilities and supply chain efficiency efforts to tackle inflation in the last quarter.

“While recent supply chain challenges, there has been no material impact on our and our bottling partners’ ability to manufacture or distribute our products. Through revenue growth management, supply chain productivity initiatives and our commodity hedging program, we have been able to largely mitigate the impact of these incremental costs” Coca Cola said in its Q3 filings.

PepsiCo also responded by taking its notional commodity hedges to a five-year high of $1.4 billion at the end of the third quarter. As per its quarterly filings, the company gained almost $525 million in realized and unrealized gains from hedges amassed in the last nine months, sufficient to counter a 2% rise in its cost of goods sold.

“We forward [hedge] by six to nine months out. So we will have a better handle on where exactly 2022 costs are going to land as we get into the first quarter of 2022” said Hugh Johnston, CFO at PepsiCo during the Q3 earnings call.

Meanwhile, the Swiss food and drink conglomerate, Nestle also emerged largely unscathed as it held notional derivatives of CHF 917m at the end of 2020, covering 2.2% of its goods sold. The company doesn’t disclose any changes within its commodity hedging portfolio in the quarterly filings.

“This [input cost inflation] has been relatively stable as far as commodities and packaging is concerned. The main reason, especially as far as the commodity is concerned, is that we had some hedging in place as well as some forward buying. So this is the reason why it didn't move much” said François-Xavier Roger, CFO at Nestle

The American producer of canned soup products, Campbell soups swift decisions in ramping up its commodity hedging program has proved effective as it reported a $0.12 (or $36.4 million) benefit to its earnings per share from mark-to-market gains on outstanding commodity hedges in the last twelve months.

The company held notional commodity derivatives worth $246 million at the end of the third quarter, 113% higher than starting of the year, sufficient to cover almost a fifth of its cost of goods sold.