WEEKLY COMMODITY MONITOR

Commodity costs continue to be a headwind for many restaurant companies.  Some relief has come around on some items but, by and large, year-over-year inflation remains an issue for all operators.

I’m beginning to sound repetitive but the pizza concepts are not getting any respite from the commodity markets of late.  The price of cheese has risen sharply over the past couple of months and, after weeks of flagging it in these posts, it seems the number of investors and analysts taking note is also increasing.  Below, I give my take on a few important points pertaining to commodity price action and the implications for individual stocks/categories.

Coffee is obviously the first item that catches one's eye in the table below.  News emerged today that demand for coffee beans from Guatemala is at a “near standstill” as roasters turn to countries with cheaper, lower-quality beans.  Brazil is also reported to have stockpiled 1.5 million bags of beans, which if released into the market “would bring some relief to a currently tight market”.   Starbucks revealed on its latest earnings call that it has effectively locked in coffee prices for the year.  GMCR, according to the most recent earnings call, had locked in six months coverage at fixed prices.  The company stated that it will “adjust our pricing as necessary”.  PEET passed along increasing costs to its customers via price increases recently.  The retail and home delivery business prices increased in the fourth quarter, the foodservice business saw an increase in January, followed by the grocery business.  The company did not disclose its current hedging strategy for 2011 (as of 3Q10, we know PEET had locked in 40% of its 2011 coffee needs), but management said it expects coffee costs to climb nearly 30% YOY.

WEEKLY COMMODITY MONITOR - coffee

Cheese prices have been a key concern and definitely are worth monitoring.  Dairy prices are receiving support from weather events (cyclones in Australia, for example), an increase in feed costs for dairy animals, and a lesser supply of dairy animals given the increased demand for meats that has seen protein costs go higher.   This is a concern for DPZ and PZZA and, as I mentioned in the Tales of the Tape yesterday, downgrades have begun and will likely continue as a result of this.  DPZ has been in the news a lot of late, with high-profile investors taking positions in the stock, but I believe the one-two punch of higher commodity costs and extremely difficult compares from a top line perspective do not bode well for the stock.  The latest news on DPZ is that the company is rolling out a new chicken menu.   While an increase in chicken sales would be accretive from a margin perspective due to relatively lower chicken costs, I think the increase in cheese – as shown below – will be a significant headwind.  On the most recent earnings call, management stated that its contract “still floats with the block.  But the way we’ve got it worked out, the contract kind of reduced about a third of that volatility”.

WEEKLY COMMODITY MONITOR - cheese

Chicken wing prices continue to provide a tailwind for BWLD earnings, declining again week-over-week.   The company’s guidance of 18% EPS growth may be revised upward if the current trend (shown below) continues, although the back half of the year will likely see less YOY favorability in chicken wing prices.

WEEKLY COMMODITY MONITOR - chicken wings

WEEKLY COMMODITY MONITOR - commodity 223

Howard Penney

Managing Director