10/27/2011 08:58 EDT | Updated 12/27/2011 05:12 EST

Maple Leaf Foods rises to profit in third-quarter as revenues dip two per cent

TORONTO - The price of bread and other baked goods may rise next year at Maple Leaf Foods Inc., as Canada's largest food processor struggles to offset rapid rises in the cost of wheat, corn and other raw materials.

Maple Leaf (TSX:MFI) CEO Michael McCain said Thursday profit margins in the company's prepared meats business are seeing healthy gains, driving its third-quarter profit to a much improved $43 million.

However, cost pressures are hurting its bakery business, under brands such as Dempster's bread and Olivieri pasta.

"The issue we have there is primarily one of significantly higher wheat prices than what we priced for, and inflationary cost increases that haven't been fully covered off by pricing," he told analysts on a conference call.

"Either reductions in the commodity, or further price increases coupled with our efficiency improvements and innovation and mix changes, is what we're going to have to get done over the next several quarters."

The price of wheat has shot up 23 per cent since October 2010, while the cost of corn has jumped 37 per cent.

McCain said Maple Leaf won't contemplate price increases until next year, when it re-evaluates where commodities are. But if costs stay high, increases are a possibility.

The company has already joined other food companies in passing along rising commodity costs to consumers. It raised its fresh bakery prices by 20 cents per unit at the end of March.

"Everybody is experiencing this issue — the combination of higher prices at retail and lower spending power from consumers," he said.

Like all food processors, Maple Leaf is being squeezed by rising ingredient costs — everything from flour used to bake bread to sugar for pies and pastries, and the pork, beef and chicken used in cold cuts and hot dogs.

Maple Leaf announced last week it is cutting 1,550 jobs, closing plants in four provinces and streamlining distribution in a continuing efficiency drive as the company also grapples with weaker sales and the high Canadian dollar, which makes its exports more expensive to foreign buyers.

Bakery earnings during the quarter were $28.1 million, largely consistent with last year's $28.3 million.

However, the company saw pressure on its bakery profit margins from higher costs, as well as about $2.3 million in duplicates costs as the company continues to operate three bakeries scheduled for closure between December and 2013 as it transitions operations to its massive new Hamilton bakery.

During the most recent quarter, the company returned to profitability with earnings of $43 million, or 29 cents per share, compared with a loss of $19.9 million, or six cents per share, in the same 2010 period.

Sales dipped two per cent to $1.26 billion from $1.29 billion. However, after adjusting for the impacts of divestitures and a stronger Canadian dollar, sales increased by six per cent, primarily as a result of higher selling prices.

Adjusted earnings, stripping out the effects of restructuring and related costs and other items, were 34 cents per share, including $9.8 million, or seven cents per share, related to a tax adjustment associated with a prior acquisition. That compared with adjusted EPS of 22 cents last year.

Analysts had been expecting earnings of 27 cents per share on revenues of $1.26 billion, according to Thomson Reuters.

Maple Leaf's gains come largely from its protein business, which is seeing hefty margin increases due to some recent changes in the company's plan, said Derek Dley an analyst at Canaccord Genuity.

"The company's market share has allowed them to pass through price increases to help offset the rise in commodity costs," he said.

In addition, Maple Leaf has been able to capitalize on the early stages of its "value-creation plan," completing several of the "lower hanging fruit" margin initiatives, he said. The company is now about 60 per cent through its plan to reformulate its product mix.

"It's things like going from 19 different kinds of bologna to two, which increases the manufacturing efficiency in their plants," Dley said.

Price increases earlier in the year to offset rising input costs also helped the company to improve adjusted operating earnings in its meat business to $20.8 million, compared to $19.5 million last year.

The company booked $4.9 million in restructuring costs as it winds down smaller bakeries and meat plants as part of a $1.3-billion consolidation plan.

Maple Leaf will book bigger restructuring changes going forward, one- time items such as severance costs, Dley said. But the company's biggest challenge continues to be the impact of the strong Canadian dollar — one of the major reasons it decided to engage in the massive streamlining of operations.

Other risks for Maple Leaf include a large capital outlay as it builds new factories, as well as harder-to-attain margin gain targets.

"They were really going from six and a half per cent margins on the protein side to eight and a half per cent by 2012, which we think is readily attainable," Dley said.

"But going from eight and a half to twelve and a half per cent is more centred on utilizing a bigger plan — better efficiencies better manufacturing processes — and I think there's more risk involved around those initiatives than what we've seen in the earlier stages of the plan."

Maple Leaf is Canada's biggest food processor, making and selling such well-known store brands as Maple Leaf, Burns and Schneiders hot dogs, Tenderflake lard, Dempster's bread, Olivieri pasta, as well as Shopsy's deli meats and Mitchell's Gourmet foods.

The company has operations across Canada and in the United States, the United Kingdom, Asia and Mexico, so it competes with global food giants and is particularly sensitive to the effects of a high Canadian dollar and rising costs for energy and raw materials.

Shares in the company rose 3.7 per cent or 40 cents to close at $11.22 Thursday on the Toronto Stock Exchange.