---
title: "Heavyweight! \"Food & Beverage Cost Research Special Report\": On the Issue of Rising Costs"
description: "Click the image for details. Key points: The food industry has enjoyed the CPI-PPI scissors gap dividend for five consecutive years, with the first half of 2017 possibly being the turning point. From 2012 to 2016, gross margins for mass-market food improved by nearly 10 percentage points, which we believe is mainly due to the scissors gap between CPI and PPI. Starting from March 2012, PPI began negative growth while CPI continued positive growth, allowing companies to benefit from falling costs. However, since November 2016, PPI has risen sharply, especially with soaring costs for packaging materials, transportation, sugar, and oil, leading us to predict the turning point of the CPI-PPI scissors gap dividend. Historically, in the second half of 2008 and in 2010, CPI and PPI inverted, and the profitability of food processing companies was generally affected for 2-3 quarters."
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published: "2017-03-01"
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# Heavyweight! "Food & Beverage Cost Research Special Report": On the Issue of Rising Costs

> Click the image for details. Key points: The food industry has enjoyed the CPI-PPI scissors gap dividend for five consecutive years, with the first half of 2017 possibly being the turning point. From 2012 to 2016, gross margins for mass-market food improved by nearly 10 percentage points, which we believe is mainly due to the scissors gap between CPI and PPI. Starting from March 2012, PPI began negative growth while CPI continued positive growth, allowing companies to benefit from falling costs. However, since November 2016, PPI has risen sharply, especially with soaring costs for packaging materials, transportation, sugar, and oil, leading us to predict the turning point of the CPI-PPI scissors gap dividend. Historically, in the second half of 2008 and in 2010, CPI and PPI inverted, and the profitability of food processing companies was generally affected for 2-3 quarters.

**Click the image for details**
**Key Points of the Report:**
**Food industry has enjoyed the CPI-PPI scissors gap dividend for five consecutive years; the first half of 2017 may be the turning point**
From 2012 to 2016, the gross margin of mass-market food improved by nearly 10 percentage points. We believe this is mainly due to the scissors gap between CPI and PPI. Starting from March 2012, PPI began negative growth while CPI continued positive growth, allowing companies to benefit from falling costs. However, since November 2016, PPI has risen sharply, especially with soaring costs for packaging materials, transportation, sugar, and oil. We predict that the turning point of the CPI-PPI scissors gap dividend will arrive. Historically, in the second half of 2008 and in 2010, CPI and PPI inverted, and the profitability of food processing companies was generally affected for 2-3 quarters. We also found that due to the strong pricing power and ultra-high profit margins of baijiu, its profitability is relatively less affected by cost fluctuations.
**Rising costs for packaging materials, transportation, sugar, and other general costs create widespread cost pressure for food companies**
PPI has risen significantly (up 6.9% year-on-year in January), and food and beverage companies face pressure from rising transportation, packaging, and some raw material costs. We estimate that transportation costs have risen by about 30%, and the industry's transportation expense ratio is generally 2.5%-3.5%, with the impact on the expense ratio being about 1 percentage point. The main packaging materials for food and beverages have seen significant price increases: corrugated paper (+55%), glass (+27%), plastic (+29%), and tinplate (45%). At the same time, some sub-sectors face pressure from rising raw material costs: international whole milk powder (up 70% from the bottom), sugar (+45%), palm oil (+40%), mustard tuber (+30%), soybeans (+11%), and glutinous rice (+10%).
**Profit fluctuation estimates by industry: alcoholic beverages are more affected by packaging materials, while food is more affected by packaging materials, sugar, oil, and whole milk powder**
In the baijiu industry, packaging materials account for 65%-70% of costs, mainly glass, paper boxes, and cartons. Without considering price increases, the impact on gross margin is about 5 percentage points. In the beer industry, packaging materials account for 25%-30%, and the impact on gross margin is about 2 percentage points. In the huangjiu industry, raw material glutinous rice accounts for 48% and packaging materials 40%, with an impact on gross margin of about 3 percentage points. For plant-based protein beverages represented by Lulu, packaging materials account for 35%-40%, mainly tinplate, with an impact on gross margin of about 5 percentage points. In the dairy industry, packaging materials account for 20%-30%, raw milk about 60%, of which whole milk powder is estimated at about 15%. International whole milk powder prices have risen 70%, and carton prices have risen significantly, with a negative impact on gross margin of about 3-5 percentage points. For condiments, sugar, soybeans, and packaging materials account for 15%, 20%, and 30% respectively, with cost pressure from both raw materials and packaging, and a negative impact on gross margin of about 4 percentage points. In the pickled mustard tuber industry, the main raw material, mustard tuber, has risen by about 30% (accounting for over 30% of costs), with a negative impact on gross margin of about 5 percentage points.
**Rising costs are beneficial to leading companies in the medium to long term, but short-term profit fluctuation risks need attention**
In the medium to long term, leading companies benefit from rising costs (their ability to pass on costs is significantly higher than that of small companies), but in the short term, price increases often lag behind cost increases, and price increases can affect short-term sales. During rapid cost increases, companies generally experience a 2-3 quarter period of declining profitability. We expect this risk may be concentrated in the first half of 2017.
**Risk warnings: 1. Significant cost increases; 2. Price increases not meeting expectations.**
**Full Report**
**Food processing companies are significantly affected by CPI-PPI, while baijiu companies are less correlated**
Food processing companies generally enjoy the dividend from the CPI-PPI scissors gap. From 2012 to 2016, the gross margin of mass-market food improved by nearly 10 percentage points. We believe this is mainly due to the scissors gap between CPI and PPI. Starting from March 2012, PPI began negative growth while CPI continued positive growth, allowing companies to benefit from falling costs. However, **since November 2016, PPI has risen sharply, especially with soaring costs for packaging materials, transportation, sugar, and oil. We predict that the turning point of the CPI-PPI scissors gap dividend will arrive.** Historically, in the second half of 2008 and in 2010, CPI and PPI inverted, and the profitability of food processing companies was generally affected for 2-3 quarters. (Note: Considering the impact of melamine on dairy products in 2008, dairy products were excluded from food processing companies.)
We also found that due to the strong pricing power and ultra-high profit margins of baijiu, its profitability is relatively less affected by cost fluctuations.
**PPI has risen significantly, and companies face cost pressure**
PPI has risen significantly, and the CPI-PPI scissors gap dividend has disappeared. In 2017, against the backdrop of rising commodity prices, PPI entered an upward channel, the CPI-PPI gap narrowed, and raw materials for food and beverages such as sugar, soybeans, and whole milk powder all rose. Packaging materials such as glass and tinplate also increased, putting pressure on costs. In January 2017, PPI rose sharply by 6.9% year-on-year, while CPI rose only 2.5%, widening the gap with CPI.
**Companies face rising transportation, packaging, and raw material costs**
Direct materials account for over 80% of the food and beverage industry generally
In food and beverage sub-sectors, direct materials (raw materials + packaging) generally account for over 80%, with packaging materials generally accounting for over 30%. Baijiu, huangjiu, and plant-based protein beverages have relatively higher packaging material proportions, with baijiu having the highest at 65%-70%.
**Transportation expense ratio in the food and beverage industry is generally 2.5%-3.5%, and transportation costs have risen significantly**
The transportation expense ratio in the food and beverage industry is generally 2.5%-3.5%, with meat products and baijiu being the lowest. We calculated the ratio of transportation expenses to operating revenue for food and beverage sub-sectors. The transportation expense ratio is generally 2.5%-3.5%, with meat products and baijiu lower at 1%-1.5%. The ranking of transportation expense ratios in food and beverage sub-sectors: dairy (3.6%) > other alcoholic beverages (3.4%) > soft drinks (3.3%) > wine (3.2%) > beer (3%) > condiments and fermented products (3%) > comprehensive food (2.7%) > huangjiu (2.5%) > meat products (1.3%) > baijiu (1.1%).
With the implementation of new transportation regulations, transportation costs have risen significantly. In September 2016, the Ministry of Transport and other departments issued the "Opinions on Further Improving the Governance of Illegal Modification and Overloading of Trucks" and the "Work Plan for the Governance of Vehicle Transporters," leading to a significant increase in transportation costs. According to estimates, transportation costs have risen by about 30%.
The impact of rising transportation costs on the sales expense ratio of food and beverage companies is expected to be about 1 percentage point. Without considering price increases, assuming transportation costs rise by 30%, the sales expense ratio for food and beverages would rise by about 0.75-1 percentage point. Overall, the impact of rising transportation costs on the sales expense ratio of the food and beverage industry is about 1 percentage point.
**Packaging material prices have risen by more than 25%, significantly impacting costs**
Various packaging material prices have risen significantly, all by more than 25%. Food and beverage packaging materials mainly include glass, plastic bottles, and cartons. Due to stricter environmental regulations, carton prices have risen significantly, with corrugated paper prices rising from over 2,000 yuan/ton to about 4,500 yuan/ton, an increase of over 55% year-on-year. Glass and plastic bottles have also risen significantly, with glass prices up 27% and plastic prices up 29% year-on-year.
In most food and beverage sub-sectors, packaging materials account for over 30% of costs. In the condiment industry, packaging materials account for about 30%; in baijiu, packaging accounts for 65%-70% of operating costs; in huangjiu, using Kuaijishan as an example, packaging accounts for about 40% of operating costs; in soft drinks, using Chengde Lulu as an example, tinplate packaging accounts for about 35%-40% of operating costs; in beer, packaging accounts for about 30%; and in dairy, packaging accounts for about 20%-30%.
**Some food and beverage companies face pressure from rising raw material costs**
Raw material costs in some food and beverage sub-sectors have risen significantly. International whole milk powder prices have risen significantly, with Fonterra whole milk powder prices up about 70% year-on-year. Currently, domestic raw milk prices have not risen significantly, but infant formula companies that rely mainly on imported raw materials face more obvious cost pressure. Sugar, palm oil, soybeans, glutinous rice, and other raw material prices have also risen: sugar up about 45% year-on-year, palm oil up about 40%, soybeans up 11%, glutinous rice up 10%, and flour up 6%.
**Rising costs in the food and beverage industry put pressure on profitability**
**Food and beverage industry:** Raw material costs for whole milk powder, sugar, and palm oil have risen significantly, with dairy, condiments, and instant noodles being most affected. Domestic raw milk prices have not risen significantly, so liquid milk producers in the dairy industry that rely mainly on domestic raw milk face relatively less cost pressure, while infant formula companies and reconstituted milk producers that rely on imported milk sources are more affected.
Since packaging materials such as glass, tinplate, plastic, and cartons have all risen significantly, by over 30%, food and beverage companies face high cost pressure from packaging materials.
**Baijiu industry:** Packaging material costs account for a high proportion, with glass, paper boxes, and cartons accounting for 65%-70% of costs. Without considering price increases, packaging material cost pressure is high.
**Condiment industry:** Packaging materials account for about 30%, with glass and carton costs rising significantly. At the same time, main raw materials such as sugar and soybeans have also risen, putting significant pressure on costs.
In the plant-based protein beverage industry, represented by Chengde Lulu, packaging materials are mainly tinplate, accounting for about 35%-40% of costs. The rise in packaging materials has a significant impact on the company's overall gross margin.
**Dairy industry:** Packaging materials account for a relatively low proportion, about 20%-30%. The main raw material, raw milk, has risen significantly internationally, but domestic raw milk prices have not risen significantly. Therefore, liquid milk producers that rely mainly on domestic raw milk are less affected, but infant formula companies and reconstituted milk producers that rely on imported milk sources will face greater cost pressure. At the same time, the dairy industry faces a narrowing price gap between domestic and international raw milk, and the risk of rising domestic raw milk prices.
**Meat products industry:** The main raw material, pork, is in a declining phase, so cost pressure is not significant.
**Profit fluctuation estimates by industry: alcoholic beverages are more affected by packaging materials, while food is more affected by packaging materials, sugar, oil, and whole milk powder**
**Baijiu industry:** Packaging materials such as glass and cartons have risen significantly, and packaging materials account for a large proportion, so packaging pressure is significant.
The packaging materials for baijiu are mainly glass, paper boxes, and cartons, accounting for about 65%-70% of operating costs.
Glass prices have risen 27% year-on-year, and carton prices have risen 55%. Without considering price increases, assuming overall packaging material purchase prices rise by 30%, based on a 75% gross margin, the gross margin of the baijiu industry would be affected by about 5 percentage points.
**Condiment industry: Both packaging materials and raw materials face cost pressure**
The raw materials for soy sauce are mainly soybeans and sugar, while the raw material for vinegar is mainly glutinous rice. Packaging materials are mainly glass and cartons. Taking Haitian soy sauce as an example, raw materials and packaging materials account for over 80% of costs, with raw materials accounting for about 50%-55% and packaging materials about 30%-35%. Soybeans and white sugar account for over 30% of costs.
Sugar prices in January 2017 rose 45% year-on-year, soybean prices in January 2017 were 4,107 yuan/ton, up 11% year-on-year, and glass prices in February 2017 rose 27% year-on-year.
Since sugar, soybeans, and packaging materials account for a high proportion in condiments, assuming soybean purchase prices rise by 5%, sugar purchase prices by 10%, and packaging material purchase prices by 15%, without considering price increases and other cost increases, the impact on gross margin would be about 4 percentage points.
**Plant-based protein beverages: Tinplate packaging material prices have risen significantly**
The main raw materials for plant-based protein beverages, represented by Chengde Lulu and Six Walnut, are almonds and white sugar, and the packaging material is tinplate. Taking Chengde Lulu as an example, raw materials account for over 80% of operating costs, with tinplate packaging expected to account for 35%-40% of operating costs.
Tinplate prices have risen significantly recently, with tinplate coil prices up 40%-50% year-on-year in February 2017. Bitter almond prices fell 18% year-on-year, but sugar prices rose 45%. We estimate that the impact of raw material costs on gross margin will not be significant, while the rise in tinplate packaging costs is the biggest variable affecting the gross margin of the industry and companies.
Taking Chengde Lulu as an example, the gross margin is about 45%, with tinplate accounting for 35%-40%. Assuming tinplate purchase costs rise by 30%, without considering price increases, the negative impact on gross margin would be about 5 percentage points.
**Huangjiu industry: Packaging material costs have risen significantly**
The main raw material for huangjiu is glutinous rice, and packaging materials are mainly glass. According to Kuaijishan's prospectus, the cost structure of huangjiu is: raw materials, packaging materials, and others account for 48%, 40%, and 12% respectively, with raw materials mainly being glutinous rice.
Currently, glutinous rice prices are up about 10% year-on-year. However, due to the characteristics of the huangjiu industry, newly brewed huangjiu generally needs to be stored and aged for a period before sale. It usually takes nearly 2 years or longer from raw material purchase to production of sellable huangjiu, so the current year's production costs are not fully reflected in the current year's sales costs. Therefore, the rise in glutinous rice prices will not be reflected in 2017. The biggest impact on the huangjiu industry is the rise in packaging material prices such as glass and cartons. Assuming packaging material purchase costs rise by 15%, with a 40% proportion and a 45% gross margin for huangjiu, without considering price increases, the negative impact on gross margin would be about 3 percentage points.
**Dairy industry: Packaging material prices have risen, and international whole milk powder prices have risen significantly**
Dairy packaging is mainly paper boxes, plastic bottles, and cartons. Corrugated paper prices are up 55% year-on-year, plastic prices up 29%, and packaging materials account for 20%-30% in the dairy industry. Based on a 35% gross margin, assuming packaging material purchase prices rise by 20%, without considering price increases, the negative impact on gross margin would be about 2-3 percentage points.
International whole milk powder prices have risen significantly, with Fonterra whole milk powder auction prices up 70% year-on-year. Domestic raw milk prices have not risen significantly. The main raw material for the dairy industry is raw milk, accounting for about 60%. Domestic liquid milk mainly uses domestic raw milk, while some reconstituted milk uses whole milk powder, so the cost of reconstituted milk has risen significantly. In addition, infant formula companies that mainly use imported milk sources will also be affected by the rise in international whole milk powder prices.
We also note that although domestic raw milk prices have not risen significantly, if international whole milk powder prices continue to rise, demand for raw milk may shift to domestic raw milk, and domestic raw milk prices may face upward pressure. Especially in the third quarter, the peak season for dairy consumption, domestic raw milk prices are expected to see a turning point in the third quarter of this year.
Dairy industry: Under the current background of no significant rise in domestic raw milk prices and a 70% rise in international whole milk powder prices (about 1-1.5 yuan/kg increase), assuming 15% of liquid milk uses reconstituted milk, the impact on dairy companies' gross margins would be about 1-2 percentage points.
**Pickled mustard tuber industry: Main raw material mustard tuber prices are significant, putting pressure on gross margins**
Raw material costs account for about 70% of pickled mustard tuber costs, with mustard tuber being the main raw material, expected to account for over 30%.
According to the latest news from Fuling Zhacai, the purchase price of mustard tuber is currently about 800-1000 yuan/ton, compared to about 700 yuan last year, up 25%-30% year-on-year. Based on a 45% gross margin for pickled mustard tuber, assuming purchase prices rise by 30%, without considering price increases, the negative impact on gross margin would be about 5 percentage points.
**Beer industry: Imported barley prices have fallen, and cost pressure mainly comes from packaging materials**
The main raw materials for beer are malt and rice, and packaging materials are mainly glass and cartons. From the cost structure, raw materials account for about 55%-60% in the beer industry, with raw materials accounting for about 30% and packaging materials about 25%-30%.
Imported barley prices have fallen 10% year-on-year and are still at low levels, but packaging material prices for glass and cartons have risen significantly. Assuming packaging material purchase costs increase by 20% overall, since main raw material prices are currently at low levels, this can offset some of the negative impact of packaging material price increases. Overall, the negative impact on the beer industry's gross margin is about 2 percentage points.
**Focus on industries with price increase potential and pay attention to short-term profit fluctuation risks**
In the medium to long term, leading companies benefit from rising costs (their ability to pass on costs is significantly higher than that of small companies), but in the short term, price increases often lag behind cost increases, and price increases can affect short-term sales. During rapid cost increases, companies generally experience a 2-3 quarter period of declining profitability. We expect this risk may be concentrated in 2017.
By studying historical data, the profitability of food processing is highly correlated with the CPI-PPI scissors gap, indicating that the food processing industry is a late-cycle industry. The timing of price increases generally lags behind cost increases, so short-term profitability is under pressure, and attention should be paid to profitability fluctuation risks.
The profitability of the baijiu industry is not highly correlated with the CPI-PPI scissors gap, indicating that the baijiu industry, unlike food processing, is not driven by cost-push price increases. The price increases in baijiu are not necessarily cost-driven.
**Focus on sectors with strong pricing power and cost pass-through ability: baijiu, dairy, and Fuling Zhacai**
**Baijiu industry: Strong pricing power and ultra-high profit margins, profitability relatively less affected by cost fluctuations**
The baijiu industry, especially high-end baijiu, has strong pricing power. Since 2016, mid-to-high-end baijiu companies have raised prices. We expect that in 2017, with rising costs, baijiu companies may continue to raise prices to pass on costs.
Through research, the profitability of the baijiu industry is not significantly correlated with the CPI-PPI scissors gap. We believe this is mainly because price increases in the baijiu industry are not necessarily driven by cost increases. Baijiu companies have strong pricing power. In early 2016, some baijiu companies had already raised prices when PPI was at the bottom.
**Dairy: Raw milk prices rise, focus on competitive landscape improvement in the second half of the year**
1) When raw milk prices fall, downstream dairy companies generally see gross margin improvements in the short term, and since promotions are relatively benign, net margins improve with gross margins. However, when raw milk prices fall to a certain level, the industry generally experiences severe price wars, leading to rising sales expense ratios, sometimes exceeding the increase in gross margins, resulting in declining net margins.
2) At the beginning of raw milk price increases, downstream dairy companies generally experience 1-2 quarters of gross margin decline, and since promotions do not immediately decrease, net margins generally decline as well. However, as raw milk prices rise, dairy companies pass on costs through price increases and reduce promotions, leading to gross margins stabilizing and recovering, sales expense ratios declining, and net margins stabilizing and recovering.
3) Taking the previous cycle as an example, in 2013, domestic raw milk prices rose significantly (up to 0.9 yuan from the beginning of the year), causing gross margins for Yili, Guangming, and Sanyuan to decline significantly for two consecutive quarters in Q3 and Q4 of 2013 (by about 5 percentage points), while sales expense ratios also declined (by about 5 percentage points). However, from 2014, a new gross margin improvement cycle began, effectively passing costs on to consumers. From the second half of 2014, raw milk prices began to fall, and companies continued to benefit in gross margins, but from the second half of 2015, sales expense ratios also increased significantly (by about 5 percentage points).
4) In summary, the beginning of cost declines and the end of cost increases generally benefit downstream dairy companies, while the end of cost declines and the beginning of cost increases generally do not benefit companies.
Fuling Zhacai: Leading pickled mustard tuber company with strong pricing power
The company currently holds about 30% of the packaged pickled mustard tuber market share, exceeding the combined share of the next top five. Since 2007, the company's ton price has increased by nearly 100%, with an annualized growth rate of 9%, far exceeding CPI growth. In July 2016, the company raised prices on 11 single products (ex-factory price + first transportation cost borne by the company), with increases ranging from 8% to 12%, demonstrating strong pricing power. In February 2017, the company raised prices on its main products, increasing the delivered prices (ex-factory price + first transportation cost borne by the company) of 9 main products in 80g and 88g specifications, with increases ranging from 15% to 17%. This second price increase highlights the company's strong pricing power.
We estimate that the company's pickled mustard tuber ton price is close to 10,000 yuan/ton. We also estimate that the main products covered by this price increase account for most of the company's pickled mustard tuber products. Without considering cost increases, the July 2016 price increase and this price increase would contribute about 5 percentage points positively to gross margin, basically covering cost increases.
**Risk warnings: 1. Significant cost increases; 2. Price increases not meeting expectations.**
**Source: Food & Beverage Wine**
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