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For grocers, rising wholesale prices could mean profit pain

There is good news and bad news for U.S. grocers on the pricing front.

The good news: The prices that consumers pay for groceries increased for the fourth month in a row in October.

The bad news: The prices that grocers pay wholesalers for groceries went up at an even faster rate.

Together, those trends threaten to squeeze profit margins at U.S. food retailers just starting to see some relief from a historic bout of consumer price deflation, analysts said.

In October, the "final demand food" component of the Producer Price Index, or PPI, rose 2.6%. The federally tracked PPI, which the U.S. Bureau of Labor Statistics, or BLS, reported Nov. 14, reflects prices that food retailers pay producers for their goods.

That increase in the overall wholesale price rate was faster than the 0.6% increase in retail food prices in the "food at home" component of the federal Consumer Price Index, or CPI, released by the BLS on Nov. 15. The CPI represents the price that consumers pay for food at retailers.

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The spread between the two metrics is used by grocery analysts and other industry watchers to gauge the state of grocers' gross margins. When PPI growth outpaces the CPI growth, grocers' profit margins are more likely to narrow. When CPI growth outpaces PPI growth, profit margins are more likely to widen.

Analysts often measure this spread by subtracting PPI growth from the growth. When the result is negative, grocers' profit margins are more likely to narrow.

In October, the spread was negative by two percentage points, marking the eighth consecutive month of a negative difference, according to a new analysis by S&P Global Market Intelligence.

"This suggests that the deflation benefit to gross margins has abated and industry gross margins are being pressured by cost increases that are not passed on," Barclays analyst Karen Short wrote in a Nov. 15 research note. Produce supplies were impacted by wildfires that ravaged Northern California in October, potentially fueling increases to the prices that wholesalers charge grocers, Short wrote.

To be sure, the national pricing trends do not affect all retailers. Despite predictions from analysts that grocers' gross margins would narrow, Kroger Co. reported Nov. 30 that its margin grew by 30 basis points during the company's fiscal third quarter. Kroger attributed the beat to higher sales of private-label products and natural foods, which are more profitable than national brands and non-organic options, and to lower costs that it negotiated with suppliers.

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Higher prices for protein and produce drove the year-over-year increase in the CPI's "food at home" category in October. Prices for meats, poultry, fish and eggs rose 1.5% over the same month one year ago, while the prices consumers pay for fruits and vegetables rose 1.4%.

Prices for cereals and bakery products declined 0.6%, while dairy and related products fell 0.5%.

The continued rebound in the prices consumers pay for food offers some hope for grocers' bottom lines after a recent spell of deflation. In July, grocery prices rose on a year-over-year basis for the first time since November 2015. But in October, analysts cautioned that a more competitive environment, fostered in part by Amazon.com Inc.'s August purchase of Whole Foods Market Inc., could force food retailers to keep prices low even as the prices that their suppliers charge increase.

In results for the company's fiscal quarter ended Nov. 4, Kroger executives said they cut prices during the quarter, much of which came after Amazon began cutting prices at Whole Foods in late August.

Grocery sales for October were $54.19 billion, up 3.2% over the same month in 2016, according to the monthly U.S. Census report.