The irony with China Foods, Cofco's unit that makes and distributes consumer-pack edible oil, wines, beverage and confectionery, is that despite accounting for 42.7 per cent of total revenue for the year to December, its packaged edible oil division took an operating loss of HK$19.8 million and net loss of HK$21.5 million.

The gross margin for consumer edible oil eroded to 7.1 per cent from 8.8 per cent the year before. By contrast, the gross margins of its other lines were as high as 52.5 per cent and 27 per cent, respectively.

Surging prices of raw foodstuff were behind the anomaly. As Tanrich Financial Group senior vice-president Colleen Chow noted, the price of bulk vegetable oil - a major ingredient in processing edible oil - rose 50 per cent last year. To make matters worse, the firm was unable to pass the higher cost fully on to consumers.

With the retail price of edible oil lagging bulk oil prices, China Foods' margin has been under pressure since last year. When Beijing capped prices on commodities ranging from grain to meat, milk, edible oil, eggs and liquefied petroleum gas in January to battle record inflation, the margin squeeze got worse.

Although the central government approved a price increase request from rival Singapore-listed palm oil refiner Wilmar International recently, analysts believe China Foods' operating environment will remain harsh this year.

Goldman Sachs analysts Deng Yifan and Joey Zeng said in a recent report that the retail price of China Foods' edible oil has been rising slower than raw material costs.

Management implied at a briefing last Tuesday that there was some inflexibility in raising selling prices to preserve margins. But as a state-owned enterprise, China Foods will have to practise social responsibility when fixing selling prices, a Deutsche Bank report said.

If mainland media reports last Wednesday were true, the National Development and Reform Commission apparently has rejected price increase applications from four soya bean oil producers and distributors including Cofco.

'At present, the price of bulk edible oil has stabilised, so we don't want to stir unreasonable expectations in the market,' an unnamed NDRC official was quoted in a mainland report as saying.

Analysts are cautious with the outlook for China Foods, expecting it to rely on earnings from its winery and beverage divisions to offset losses in the edible oil and confectionery lines.

Of the four divisions last year, only winery had a better than expected 42 per cent net profit growth. It makes and sells the popular 'Great Wall' brand of red and white table wines.

The beverage division, which runs seven plants to bottle and distribute Coca-Cola drinks in 12 provinces and three cities on the mainland as a franchisee, saw sales rise 23.7 per cent while net profit slid 8 per cent on higher selling prices.

Losses in the confectionery division widened to HK$37 million last year from HK$15 million on stiff competition and the rise in distribution expenses.

Deutsche Bank analyst Mabel Wong said that from this year to 2010, wine and soft-drink bottling would fuel growth but the confectionery division would break even, at best. She remained concerned that edible oil would be a drag on earnings.

Ms Wong assumed a loss of HK$50 million from edible oil this year and an even steeper loss next year 'if input costs heighten'.

By contrast, China Agri-Industries, a sister company and also the supplier of bulk edible oil, does not have to worry too much about passing on rising raw material costs down the value chain.

On Wednesday last week, the Cofco unit - with five core income streams of oilseed processing, biofuel, rice trading, brewing materials and wheat processing - delivered better than expected net profit growth of 46 per cent to HK$1.1 billion for last year, thanks to robust domestic demand for its products and their rising prices.

'In the face of soaring global soft commodity prices, all the top-tier industry players, including our company, managed to increase their product prices in a bid to pass on the cost pressure to downstream customers,' China Agri-Industries said in a filing with the Hong Kong stock exchange.

Lu Jun, an executive director and vice-president, even talked about a wide window of opportunity in the oilseed processing segment. The company plans to expand production capacity by 3.45 million tonnes to capture rising prices.

The oilseed processing division, which crushes imported soya beans to extract and refine soya bean oil, was the largest revenue and earnings contributor last year. Its sales growth was 44 per cent, mainly thanks to 50 per cent higher selling prices for bulk oil and 29 per cent for oilseed meal.

However, its gross margin dropped to 4 per cent from 5.5 per cent after providing for HK$381 million in unrealised hedging loss stemming from the mark-to-market effect of outstanding futures contracts. China Agri-Industries expects to recover fully in the first half when the products are physically delivered. Stripping out the unrealised loss, its gross margin would have been 5.9 per cent.

In the first half, prices of soya bean and related products have been less volatile, note Citi analysts Howard Pang and Graham Cunningham. The company should see less hedging loss, they say.

China Agri-Industries is not without setbacks, however. As a spin-off from China Foods in March last year, it initially intended to expand its biofuel division to produce ethanol, earmarking HK$1.76 billion or 86 per cent of its capital expenditure for last year for such projects.

But, with food prices soaring, Beijing banned the use of grains to make biofuel recently to hold back inflation, prompting the company to switch to tapioca and other feedstock. This year, management said it would use HK$1.1 billion to fund production capacity in oilseed processing, with 35 per cent allocated to biofuel projects.

Citi voiced approval for the strategy. 'We view this diversified growth strategy as favourable as it reduces the company's exposure to the country's policy changes in any of its five business divisions,' the investment bank said in a recent report.

The company also will benefit from the strengthening yuan and a ban on foreign players holding a controlling stake in soya bean and rapeseed processing facilities.

Meanwhile, its biofuel business, a victim of policy changes, also sees a silver lining.

China Agri's non-grain biofuel plant - also the first in the country - came on stream earlier this year. The government is in the process of determining the subsidy level for each licensed plant according to construction costs so that manufacturers can maintain a reasonable return from a pioneering business.

Analysts prefer China Agri-Industries to China Foods for another reason - its low valuation.

ABN Amro analyst Yang Lei worked out that the company was trading at 13.5 times forecast earnings for this year and 11.7 times for next year.

Bloomberg calculated China Foods' price-earnings ratio at 24.69 times for this year, compared with China Agri-Industries' 13.19 times.

In this era of volatile markets, being priced cheap is also important for investment sentiment.

So, judging from the performance of these two Cofco units, it is far luckier to be on the upper end of the value chain when commodity prices are rising.