Agricultural commodities went higher, week-over-week, with just a few exceptions. Despite prices coming down during the latter part of the quarter, 2Q earnings are likely to hit on significant spot market inflation for many restaurant companies.
Corn, sugar, and wheat prices went sharply higher week-over-week. Coffee and cheese were the only commodities to decline over the last week. Coffee traded with a tight inverse-correlation to the US Dollar.
Corn prices have gained strongly over the past few weeks, reassuming the positive trend that has prevailed for much of the past twelve months. China, the second largest consumer of corn globally, may more than double purchases to a record as it seeks to boost stockpiles and cool the fastest inflation in three years, according to Bloomberg. Corn is up 95% year-over-year, which continues to pressure the food processors. While some companies like SAFM may have corn hedged at favorable prices currently, as the TSN management team candidly put it during its most recent earnings call, to the extent that contracts are rolling over in the next six months or so, margins are likely to remain depressed in that space in FY12. Below is a selection of comments from management teams pertaining to corn prices from recent earnings calls.
- CMG (4/20/11): The only things we have locks on corn for most of the year, rice for the entire year, our tortillas and beans for most of the year as well. Hedgeye: CMG will likely have to renew any corn contract at a level far higher than the one it currently holds.
- MCD (4/21/11): And so if the commodity markets move significantly from here and the main ones obviously looking at beef, looking at corn, wheat, coffee, et cetera, our guidance reflects where the markets are today. Hedgeye: Looking at where the prices of these commodities have gone since this quote, one would have to think guidance for commodity costs are going higher.
Coffee prices have declined sharply week-over-week as the dollar has, week-over-week, strengthened. Over the last couple of days, the price of coffee has gained as the dollar has faded. For the coffee concepts, SBUX, PEET, GMCR, MCD, DNKN, CBOU, and THI, rising commodity costs are a serious concern. While some of these companies have prices locked in, to the extent that contracts may be coming up for renewal, prices are likely to burden restaurant-level margins sooner or later. Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls.
- PEET (5/3/2011): We believe we're better off lowering our earnings guidance by $0.10 this year and continuing with the plans we have in place than we would be curtailing spending activity or taking extraordinary pricing action that would be inconsistent with our long-term business interests, and the more sustainable long term cost of coffee we foresee. As a result, you will see throughout our call today that we have a very strong performing fundamental business, but we have to buy some unusually high priced coffee in the short term, then we're not going to do unnatural things in reaction to an unnatural market environment short term. Hedgeye: We’ve noted this before: coffee prices trade on a very tight inverse-correlation to the US Dollar. While it seems that price may have been “unusual” to management teams in May, it is taking quite a while for prices to adjust, making these levels less and less unusual.
- GMCR: (5/3/11): Before closing, I also want to touch on rising coffee costs and the effect of our business. Like others in the industry, we are closely watching coffee prices. When we announced our last price increase in September of 2010, coffee prices had increased roughly 30% from $1.45 to $1.90 per pound over the course of roughly three months. Since then, costs have continued to escalate, recently hitting historic highs of more than $3 a pound, a nearl 60% increase since September. In attempt to offset rising green coffee costs, as well as increases in other input costs, we are currently in the process of raising prices for all packaged types. We expect that consumers will see an increase of approximately 10% at the point-of-purchase as the result of this price increase. We expect to see the full benefit of this price increase during our fiscal fourth quarter of 2011. We generally fix the price of our coffee contracts three to nine months prior to delivery so that we can adjust our sales prices to the marketplace. Hedgeye: Coffee has backed off the “historic” high of more than $3 per pound but is still at $2.60 plus. Demand remains strong; without a rising dollar, expect price to continue to pressure retailers.
- SBUX (4/27/11): Regarding coffee costs, as I have indicated previously, we have fully locked our coffee costs for 2011 and are price-protected for a couple months into fiscal 2012. As we progress through the balance of 2011, we will progressively take actions to secure our coffee needs and lock coffee costs for additional months into 2012. While we expect that the costs we pay for coffee may be higher in '12 than they are in '11, we remain confident that we can offset those increased costs and preserve our long-term earnings growth targets. Hedgeye: SBUX is confident that it can pass on price and offset coffee inflation with other efficiencies. It is interesting that it expects higher coffee prices in 2012 than in 2011, which would somewhat contradict PEET’s assertion that in May that prices at the time had been unusual. SBUX expects worse prices to come.
Cheese prices have come down sharply over the last week but remain above the 1Q highs. For DPZ, PZZA, CAKE, YUM’s Pizza Hut and other restaurant companies, this is a crucial data point. CAKE has been maintaining a +2.5% inflation target in the back half of the year after +4.5% in the 1H (guided, not reported). Looking at commodity costs, and dairy in particular which is important for CAKE’s basket, the implausibility of this +2.5% target is clear. Some large holders of DPZ have been paring their positions of late as cheese prices have marched higher. Given the volatility in dairy markets this year, it is unwise to extrapolate any given data point, but trusting the guidance of management teams on cheese prices could prove equally unwise. Below is a selection of comments from management teams pertaining to cheese prices from recent earnings calls.
- JACK (5.19.11): “Cheese also accounts for about 6% of our spend and we continue to expect a 15% increase for the year.” Hedgeye: This is a headwind for JACK – cheese prices are up more than double the 15% guidance.
- DPZ (5.5.11): “And really the one to watch as always is cheese and our best bet right now is that it's going to stay relatively close to where it is right now but cheese is the one that often gives the biggest surprises either up or down and that's the one to kind of watch but assuming cheese stays relatively flat from here on out then, the absolute food costs from – through the rest of the year are probably going to stay pretty consistent with where they were in Q1 which to your point means the percentage year-over-year increase will probably ease a little bit over the course of the year.” Hedgeye: Hope is not an investment process. DPZ’s earnings call took place at a trough in cheese prices. I expect a different tone on the next earnings call in discussing this particular item.
- CAKE (4.20.11): “The first half of the year, we're expecting food cost inflation of about 4.5% plus and then in the last half of the year, about 2.5% minus. And a lot of that has to do with the fact that we expect to lap a lot of high dairy costs from 2010 and the fourth quarter of 2011, but also due to the fact that we expect to have slightly lower fresh fish costs, slightly lower cheese prices, than last year as well.”
- CMG (4.20.11): As we move into 2011, we’re expanding our use of cheese and sour cream made with milk from cows. Hedgeye: This company has driven sufficient traffic to gain leverage over commodity costs but, I would caution, some margin pressure is likely from their unparalleled exposure to commodity spot markets.