Despite drought, food stock outlook is not entirely arid

Is the following statement true, false, or true and false? Drought or, at the least, arid weather patterns in many parts of the United States inevitably lead to higher inflation and hard times for food and agribusiness companies.

If you said ``true and false,'' you are probably closest to the mark, many economists say. Granted, as the US Department of Agriculture acknowledges, there will be upward pressure on the price of some commodities and vegetables because of the drought. Nor can it be denied that many agribusiness companies, not to mention scores of farms, will face financial difficulties because of the searing temperatures throughout large parts of the US.

But there is also rising evidence that the immediate impact of the drought may not be as severe as had been initially thought, in terms of the overall inflation rate, as well as the effect on food and agribusiness companies. That's good news for Wall Street, which is currently focusing on the US food/inflation equation with particular care.

Federal Reserve Board chairman Alan Greenspan told Congress last week that a potential rise in inflation would be dealt with by the Fed as necessary, even if that meant boosting short-term interest rates. Food costs, of course, are one key variable in the overall inflation picture. And for companies in the food and agribusiness sector, where profit margins can be very tight, higher inflation can have particularly serious consequences.

Yet, according to Mitchell Held, an analyst with Smith Barney, Harris Upham & Co., the immediate impact of the drought on consumer food prices might not be as severe as is generally perceived.

Grain prices, for example, are expected to move up. But those moves will to an extent be offset by falling cattle and hog prices, since so much livestock has been herded to slaughter. And looking ahead a year, says Mr. Held, new grain plantings will lead to price declines for many of those same producers.

Indeed, Ron Morrow, Smith Barney's food analyst, believes that food price inflation will probably be no higher than 5 percent this year. That is up from an earlier forecast of 3 to 4 percent. Mr. Morrow's ``worst-case scenario'' is 6 to 7 percent.

Since ``food at home'' is given a weighting in the consumer price index of 10 percent, the actual inflationary impact of higher food prices should be fairly modest, says Morrow. Smith Barney continues to believe that inflation will rise 4.5 to 5 percent during 1988.

Analysts also point out that the drought, bad as it is in the upper Midwest, is not having a particularly negative effect on the nation's biggest agricultural region, California. California produces nearly 11 percent of the nation's total farm output.

California agriculture, in fact, has been in a process of recovery, says Frederick Cannon, the head of California Economic Forecasting, at the Bank of America, San Francisco.

Farmers there, Mr. Cannon says, continue to gain control over farm expenditures, their sales of farm commodities are increasing, and land values are stabilizing. Ironically, says Cannon, ``the drought may have helped California agriculture.''

``Cotton prices,'' for example, ``have been forced up somewhat because of the drought conditions elsewhere,'' he says. And California's fruits and vegetables, some of which compete with commodities from the Midwest, have not been adversely affected, he says.

During 1988, reckons Cannon, cash receipts from farm marketings in California will climb to $15.2 billion from $14.8 billion, a 2.7 percent increase. California farm exports will reach $3.8 billion, up more than 8 percent from 1987.

What does all this mean for investors? John McMillin, an analyst with Prudential-Bache Securities Inc., does not believe that long-term food related holdings should be altered because of the drought. That is not to say that, as Mr. McMillin points out, investor confidence in food issues has not been hurt. It has. Pru-Bache's group of 14 packaged food companies, for example, declined 0.8 percent in June, compared with a 4.3 percent gain for the Standard & Poor's 400.

But the downturn in some food stocks is not just a reflection of current weather conditions. For the first six months of this year, packaged food stocks underperformed the market. They rose only 6 percent. Looked at over the last 12 months, food company stocks were off 16.2 percent, says McMillin. Yet, the broader market showed a decline of 10.6 percent over that same period.

Still, McMillin believes that prospects for food stocks remain bright over the long haul.

He recommends a number of packaged goods companies, including Campbell's Soup, Gerber Products, Hershey Foods, Kellogg Company, and Kraft Inc.

Agricultural and meat and poultry companies he likes include Archer-Daniels-Midland, GoodMark Foods, and Hormel.

Apart from concern about the drought and rising inflation, one of the more important pieces of news was Friday's report on US merchandise trade. The report showed the trade deficit rose only slightly in May - welcome news to the financial community.

For the week ended July 15, the Dow Jones industrial average closed up 23.30 points, at 2,129.45