By Matt Andrejczak

A plunge in commodity prices late last year is causing havoc among first-quarter corporate earnings this month, as many companies find themselves caught on the wrong side of their financial programs to hedge against volatile moves in oil, corn and grain prices.

Moves to lock in prices when commodities were soaring last summer have now backfired after the prices suddenly plunged in the final months of the year, pinching companies from airlines to food makers to oil providers. At the same time, companies that avoided locking in future commodity prices should stand to benefit.

"It's a sophisticated business that not everyone is good at," said John Langston, senior analyst at Dallas-based Hodges Capital Management. "Even the best hedgers could get hurt."

This week, the parent companies of United Airlines and American Airlines reported hedging losses on bets they made on jet fuel, which has collapsed in price the past six months. Delta Air Lines, which reports earnings Jan. 27, could very well be blasted by the same headwind.

Even Southwest Airlines, well-known for successful bets on oil prices, took a $117 million charge in the fourth-quarter related to its fuel hedges. The low-fare carrier further unwound most of its fuel hedges extending out to 2013.

Elsewhere, meats producer Tyson Foods Inc. (TSN) on Monday is expected to take a hefty write down on its feed-grain hedges, with one analyst predicting the write-down could be as large as $100 million. And the decline in agricultural commodity prices may also affect hedging programs at other food makers, as General Mills proved last month.

While the plunge in commodities is a much-welcomed relief for companies who struggled to cope when prices blasted to record highs last July, the eye-popping price drop in the commodities basket does put pressure on corporate balance sheets.

Soured hedges could force companies to record them in their operating segment earnings, prompting mark downs or write offs - moves that shave profits and squeeze cash from operations. Many food companies, for instance, consider hedges an "unallocated corporate expense" until a contract is closed. The gain or loss is then recorded on the profit line.

To Hedge Or Not To Hedge

Companies use hedges to protect themselves against volatile swings in commodity prices, smoothing out some of the peaks and valleys in the commodities market by managing risk through futures and options buying. But when prices sink or skyrocket over a short period of time, not all corporate hedging programs will come out above water.

Pilgrim's Pride (PPC) got swept aside by the commodities rollercoaster. The No. 1 U.S. chicken producer went bankrupt a month ago, in part on bad corn bets.

Smithfield Foods (SFD) said "long grain positions through our hedging program" would likely make its hog production division unprofitable until this spring. This is in spite of declining hog raising costs.

Airlines have shown wrong-sided hedges take a toll on free cash flow - or money that's left over each quarter after all necessary expenses are paid.

United's (UAUA) hedging strategy cost it $936 million in total recorded losses for the quarter ended Dec. 31, putting its free cash flow at negative $1.1 billion.

American (AMR) had to post $575 million in cash collateral with fuel hedge counterparties. And Delta (DAL) has said it could post $1.1 billion in cash collateral. On the flip side, declining oil prices will help the airlines.

A much-weaker price for crude, once close to a $150 a barrel and now around $40, is spoiling profits at ConocoPhillips (COP) and Chevron Corp. (CVX).

Conoco, the No. 3 U.S. oil provider, said Jan. 16 it plans to write down the value of its existing oil reserves and operations by $33 billion, after tax. The non-cash mark down includes a $7.3 billion write-down of its stake in Russian oil company Lukoil.

Chevron, No. 2 U.S. company, warned Jan. 8 its fourth-quarter earnings were shaping up to be "significantly lower" than the third quarter.

General Mills, the top performing food-maker stock in 2008, illustrates what a hedging program can cost. The cereal maker "may find itself over-hedged in a falling commodity world," analyst Jonathan Feeney of Janney Montgomery Scott said in a recent research note.

For the quarter ended Nov. 23, General Mills (GIS) marked down $269 million on certain commodity hedges and grain inventories, subtracting 49 cents from its earnings.

Because the hedging losses are non-cash, paper losses that are one-time in nature, "We are not concerned by these losses, and we believe the market looks past these losses and focuses more on the results of the underlying business," said Edward Jones food analyst Matt Arnold.

Kraft Foods (KFT) will be another one to watch when it reports earnings Feb. 4. The No. 1 U.S. food maker highlighted in its October report that its earnings-per-share growth was somewhat blunted by a $140 million hedging losses, offsetting the earlier benefits of some restructuring moves.

While there is no question companies should benefit this year from the commodity-bubble burst, companies that didn't employ advanced hedging programs should get a real nice tailwind.

Poultry producer Sanderson Farms (SAFM) doesn't hedge it corn costs, nor does egg producer Cal-Main Foods (CALM), while fruit supplier Fresh Del Monte (FDP) buys its bunker fuel at spot market prices.

Panera Bread (PNRA) has made its bet on wheat prices, locking in its total 2009 wheat needs for a price of $9.50 a bushel, vs. prices earlier last year of $13 or $14. March wheat futures are trading around $5.66. The retailer does not purchase options or futures, but instead enters contracts with wheat mill operators to purchase wheat at a planned price, spokesperson Linn Parrish said.

Analyst Jeff Farmer of Jefferies & Co. calculates that this will pad the baker's earnings by 32 cents a share this year, making wheat-cost savings the biggest profit driver for Panera.

-By Matt Andrejczak; 415-439-6400; AskNewswires@dowjones.com

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