ConAgra's Failed Hedges — the Food/CPG Sourcing and Trading Conundrum

Earlier today, ConAgra Foods reported a significant 4th quarter profit drop of 13% according to the Wall Street Journal. The company blamed its earnings shortfall in part on "continued hedging losses" and the article noted "ConAgra has been hurt by hedging losses as commodity prices tumble from last year's highs". One of the challenges that companies like ConAgra face is a bit ironic when it comes to mitigating commodity price increases through financial instruments like options, futures and swaps. And that's the fact that they must mark the value of hedges that fall under non-hedge accounting rules to actual market value at the quarter's end (versus when the value of the hedge is actually realized). Hence, a strategy to "mitigate risk" in the first place can actually increase risk around earnings -- at least in the short term.

I tried to explain the difference of non-hedge and hedge accounting rules when it comes to commodity purchases earlier this month noting that "If a company is buying oil or jet fuel, they must treat any hedge contract under non-hedge accounting rules (and will take an earnings hit if the hedge moves in the wrong direction, even in the short-term)... But if they are buying a commodity that goes into their own production (e.g., metals, corn, resin) and opt to mitigate commodity risk through a hedging strategy, they can opt to use hedge accounting, which does not require the same level of marking-up or marking-down the "investment" as a hedge on the balance sheet.”

What happened in this situation? My working hypothesis is that ConAgra probably hedged a number of their commodity buys when the market was higher and that GAAP reporting rules are what is causing them to note the earnings loss (versus an actual impact to cash flow). If you're curious about how CPG/food companies approach hedging, it’s worth reading this column that I penned after Ariba LIVE about Del Monte's hedging approaches that notes that the company "does all of this with an eye not to speculation like a Cargill trading operation, but with the 'goal to minimize volatility to the business' ".

How do companies decide to hedge or not? "In certain situations, choosing to lock via a hedge or direct futures contract with a supplier is not the right decision based on what their own data and forecasting tools are telling them ... But Del Monte does have numerous ways of locking should they choose to use volatility management tools ... These include forward contracts with suppliers with contractual price locks, forward contracts with contractual price caps (e.g., with float down clauses that do not exceed a cap), supplier volatility assumption or supplier coverage, cross hedges, futures, swaps and options. Del Monte is also gaining access to greater and greater instruments on a regular basis as commodity markets become more fluid and global."

From a procurement, risk management and shareholder perspective, we should applaud companies that recognize the value in taking risk off the table through hedging. But most important, it’s essential to do so on a consistent basis even if, as Del Monte found, short-term earnings blips will be an interim consequence of such strategies. Even Southwest, a company that has been much touted for its hedging strategies regarding jet fuel, had to take significant write-downs on the value of some of its hedges earlier this year -- which directly impacted earnings -- as prices dropped. Which is further proof that sometimes the right long-term strategy for shareholders is not the right short-term strategy for Wall Street traders who look at near-term performance in a vacuum.

Jason Busch

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