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If consumers in Asia develop a fondness of pizza and cheeseburgers, what happens to CAKE's margins?

Cheese prices led the gainers last week, rising 4.1% to new highs which will surely put some pressure on CAKE’s 2H11 commodity guidance.  TXRH, too, has some dairy exposure and will likely be watching this recent price surge in dairy prices with keen interest.  Apparently, the growing popularity of pizza and cheeseburgers in Asia is driving cheese prices higher!  Coffee prices nose-dived week-over-week as concerns grew that a slowing global economy may bring slower demand.  Beef prices slid as news on Russia’s increase in beef and poultry production in 1H11 emerged.  Corn prices also dropped as yields in Ukraine’s average grain crops were 20% higher than last year.  However, concern over the hot and dry weather in the U.S. cutting yields has pulled prices higher for the second consecutive day.



Cheese prices are not supportive of CAKE’s call for +2.5% inflation in 2H11 versus +4.5% in the first half (guided, not reported).  Looking at the chart below, it is clear that dairy – as an important component of CAKE’s commodity basket – is far in excess of the average 1H11 price.   Kraft has cited Asia’s growing demand for pizza and cheeseburgers as being a driver of cheese exports from the U.S.  Recently, 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.


  • 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 has been taken (last night's earnings) and cheese was cited in particular.  If dairy prices continue higher, CMG could see food costs negatively impacted.  The company is rolling out a 4.5% price increase, however, as our note from earlier this morning discusses in more detail.
  • TXHR (5.2.11): “We've also got a lot of flow in the dairy markets, in cheese, so there's other things beyond produce that do move around throughout the year.”  Hedgeye: In 1Q09, TXRH called out favorable beef and cheese prices as being primary drivers of cost of sales being down 126 bps in the quarter.  We think it is highly likely that cheese will be a contributor to a cost of sales increase in 2Q11.


A stronger outlook for the dollar is bearish for coffee and coffee prices slid almost 9% after a -2.7% decline last week.  While prices remain elevated, up 52% year-over-year, the past couple of weeks’ decline is positive for SBUX, PEET, GMCR, MCD, DNKN, CBOU, and THI.  Even taking this recent decline into account, the still-elevated level of prices means that any coffee concepts that have to renegotiate contracts may face an increase in food costs on their P&Ls.  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 nearly 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 higher prices to come.

Live Cattle

Beef prices have declined -2.7% week-over-week to +18.5% year-over-year.  Corn prices moving higher over the past couple of days has provided some price support but news of Russia’s meat and poultry production surging 3.8% YTD boosted supply.  Additionally, news of contaminated beef in Japan as a result of cattle from the area near the crippled nuclear power plant in Fukushima may also have an impact on prices.  Japan’s government said it “can’t rule out” the possibility that contaminated beef has been exported.

As we mentioned before, the slaughtering of livestock in Texas and surrounding areas suffering from drought may have provided some relief in beef prices.  According to the Henry County Local this morning, cattle need 13 to 20 gallons of water in hot weather.  The arduous and costly task of maintaining herds could be leading to further slaughtering of cattle.  While this boosts supply in the short term, it could mean smaller herds and higher prices over the intermediate term.  Below is a selection of comments from management teams pertaining to beef prices from recent earnings calls.


  • RRGB (5/20/11): Ground beef could be higher by as much as 20% year-over-year, which has a meaningful negative impact to our margins.  Hedgeye: live cattle prices are up +18.5% y/y.
  • JACK (5/19/11): Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance. For the full year, we are now anticipating beef cost to be up nearly 14% versus our previous expectation of 9% inflation. We expect beef cost to be up approximately 14% to 15% in the third quarter. 
  • WEN (5/10/11): We communicated to you back in March that we expected beef cost to rise approximately 10% to 15% and that we expected our total commodity costs to rise 2% to 3% in 2011. We are now forecasting that our beef cost will rise 20%. Hedgeye: there is moderate upside risk to beef price guidance for WEN.
  • EAT (4/27/11):  Well, consistent with what we've talked about in the last month or so as we visited many of you, beef continues to present the most significant inflationary pressure in our commodity basket.
  • 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. If they stay around these levels, the 4% to 4.5% [commodity guidance for 2011] should be locked in. If they move dramatically up or down, then we'll have to reflect that as we move forward. Hedgeye: inflation guidance may have to be adjusted higher.
  • MRT (5/4/11): Q: I wanted to revisit the overall expectations for your commodities basket, and I missed the part about beef, just wanted to verify that it was up in the 20% range.  A: no, no, no.  I said in the low double-digits.  Hedgeye: This is possible, even probable, for the year looking at average 2010 versus average YTD 2011 prices, and given the easier compares in the fourth quarter, but will require no sustained upturns from here.

Howard Penney

Managing Director

Rory Green