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COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT

Here is a comprehensive view of top line trends in the casual dining category heading into earnings season.  Investors understand that commodity costs are elevated.  The main battleground in the over-crowded casual dining category is growing same-restaurant sales.  Most concepts in the category are still highly focused on attracting traffic through value-focused offerings with others focused on attracting traffic to quieter day parts while increasing turnover during busier times of the day. 

 

 

DIN

 

Applebee’s

 

Applebee’s has been an industry leader in the Bar & Grill category for some time and, along with Chili’s, is taking share from some of the weaker players.  While I believe that Chili’s is momentum is improving at a faster rate than Applebee’s, I would be remiss to ignore the strong performance of the Applebee’s system over the past three quarters.  With an easier compare, on a sequential basis, in 2Q than 1Q, I would expect Applebee’s system same-restaurant sales to accelerate on a one-year basis in 2Q.  Furthermore, the trends in the Knapp Track casual dining same-restaurant sales index have been strengthening of late; given how important the Applebee’s system is for that index (its sheer number of units), I would expect the improving two-year average trends to continue.  Indeed, any positive same-restaurant sales print for Applebee’s company sales would imply acceleration in two-year average sales.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - applebee s system pod1

 

 

IHOP

 

IHOP is a disaster and, as the chart below illustrates, has been underperforming the broader casual dining space by a growing margin as time rolls on.  Management is floundering in its attempts to provide promotions that will attract sufficient traffic and commentary highlighting the need to “better differentiate the customer experience to drive sales and regain momentum” does not inspire confidence.  IHOP is a small part of DIN’s business but the lackluster performance is disappointing nonetheless.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - ihop pod1

 

 

BJRI

 

BJ’s restaurant is currently being awarded a lofty multiple of 17.8x EV/EBITDA NTM.  Considering that DIN is currently

trading at 9.3x, and is the second most highly-valued company in the casual dining space behind BJRI, investors are clearly willing to pay up for the unit growth potential that BJRI offers.  In terms of top-line trends, the company bounced back strongly post-recession.  Last quarter’s company same-restaurant sales growth of 7.8% growth was an acceleration from the comp printed in the fourth quarter of 2010 despite a far more difficult compare for the first quarter.  Management struck a cautious tone regarding the second quarter, stating on March 20 that, excluding the shift in the Easter holiday and spring break vacations, same-restaurant sales were estimated to be trending at approximately +5.5%.  This would imply a sequential slowdown in two-year average trends of 70 basis points. 

 

Looking at California Sales Tax receipts for the second quarter, it seems that consumer spending in the Golden State was robust during April, May and June.  The two-year average trend, however, in sales tax receipts was slightly down.  Approximately half of BJRI’s restaurants are in California so the chart below suggests that strong 2Q trends could be in store for BJ’s California units.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - bjri pod1

 

 

DRI

 

Darden is a consensus long but unless you have a bearish outlook on the space, it would not be an ideal play on the short side either.  DRI recently reported earnings for their fourth quarter and full fiscal year 2011 recently.  As the charts below show, the three primary concepts all saw declines in two-year average trends from the third fiscal quarter.  The Olive Garden same-restaurant sales disappointed; two new entrée dishes – soffatelli with braised beef and soffatelli with chicken – drove traffic in line with the industry benchmark but fell short on average check.  Additionally, despite raising prices at OG in 4QFY10, management decided against it in 4QFY11.  Rather, management will introduce a new core menu and related pricing during the present quarter, the first quarter of fiscal 2012. 

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - olive garden pod1

 

 

Red Lobster’s top-line during the fourth fiscal quarter was strong but two-year average trends did decline 90 basis points sequentially to -0.4%.  Management announced on the conference call that the Red Lobster value promotions, was having a big impact on same-store sales.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - red lobster pod1

 

 

LongHorn printed a +6% same-store sales number for the fourth fiscal quarter, exceeding consensus expectations but implying a sequential slowdown in two-year average trends.  LongHorn has been a consistent performer for Darden and has one last quarter of (relatively) easy comps before facing the +6.8% number of 2QFY11.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - longhorn pod1

 

 

MRT

 

Morton’s is a company that has benefitted from the strong rebound in consumer confidence in higher income brackets.  The rebound in equity markets (QE2) has corresponded with a steadying increase in the top-line performance of Morton’s on an absolute scale and, also, relative to the FSR Index.  During the earnings call on May 4th, management stated that “The Morton's business continues to align perfectly with business travel and entertainment. Hotel RevPARs, as well as occupancy are on the rise, driven primarily from increased business travel Monday through Thursday.”

 

We would be of the opinion that, as much of a beneficiary as MRT has been of the rebound in capital markets, a slowdown from here could impact its business severely, as was the case in 2008.  The company is guiding to margin expansion, driven by traffic and price (currently ~6% price on menu), in the second and fourth quarters of 2011 but expects 3Q to be “tough” due to lower traffic volumes over that period.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - morton s pod1

 

 

EAT

 

Chili’s

 

Ruby Tuesday’s CEO Sandy Beall’s statement that the Chili’s $6 lunch was having an impact on Ruby Tuesday’s lunch business was telling.  Clearly the RT business is suffering but for the CEO to call out Chili’s specifically was significant.  Given the size of the Chili’s system, the strong performance of the Knapp Track is also encouraging (as it is for Applebee’s).  Another struggling casual dining competitor, CBRL, also highlighted “two very large chains” that are “on a big rebound” as being largely responsible for sending the Knapp-Track figures higher and the CBRL Gap-to-Knapp spread wider.  The two chains CBRL management was referring to are obviously Chili’s and Applebee’s. 

 

We believe that Chili’s will continue to execute from a top-line perspective in 2Q and, in the process, win over previously skeptical investors.  Broad guidance for the year is for “flat-to-down 2%” but, given the strong trends in casual dining, per Malcolm Knapp’s data, it seems likely that two-year average trends will accelerate in 2Q.  A print above -1.2% would imply a sequential acceleration in two-year average trends.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - chili s pod1

 

 

RUTH

 

Ruth’s Chris is has seen solid improvement in its two-year average trends over the last three reported quarters.  There are certainly many things to like about this name: a lower average check ($70) than many peers, positive traffic for five consecutive quarters, and the stock is trading at the lowest EV/EBITDA multiple of any restaurant company.

 

In order to imply two-year average trends in line with those from 1Q11, Ruth’s Chris comparable restaurant sales will need to come in at +1.8% or better.  1Q11 was a stern test for RUTH comps given the significant step up in the difficulty of the compare in 1Q10 and, given the strength of 1Q11 comps and overall industry trends, we would expect 2Q to produce strong top line trends. The company is benefitting from TV advertising which it rolled out in 1Q and, while “comping” the impact of this advertising may prove difficult, for this year it should provide a significant benefit.

 

Given the overall trend in casual dining, and the fact that confidence levels among higher income consumers, while declining of late, has not declined as sharply as confidence has among consumers in many other income brackets. 

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - ruth pod1

 

 

RT

 

Ruby Tuesday’s sales trends were poor during the most recently reported quarter, the company’s third fiscal year of 2011, and management were quick to blame weather, high gas prices, and the economy for sluggish performance.  Management also highlighted Chili’s $6 lunch and “two very large chains” (Applebee’s and Chili’s) taking share as thorns in RT’s side.  It will be interesting to see if the fourth fiscal quarter, which reflects a period of relatively robust casual dining sales trends, also proves disappointing for RT. 

 

4QFY11 comps for RT need to come in higher than -2.2% for a sequential improvement in two-year average trends.  While it seems that this is likely, given the impact of weather on the first quarter, investors will look for strong improvement and convincing management commentary supportive of better trends.  RT, at 6.6x EV/EBITDA, is currently one of the cheapest stocks in casual dining but I would look for more catalysts, and conviction on sales trends, before getting more constructive on this name. 

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - RT POD1

 

 

PFCB

 

Bistro

 

Sales at both concepts have lagged the industry over the last couple of quarters and, taking the management team’s commentary around April into account, it seems quite possible that 2Q will disappoint also.  Specifically, management stated that January and February results were in line, March surprised to the downside and, at both concepts, April trends deteriorated from there, down -3% excluding the -2% impact of the Easter calendar shift.  In order for the Bistro to maintain two-year average trends in the second quarter, a same-restaurant sales number of -2.2% or better is required. 

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - bistro pod1

 

 

Pei Wei

 

Pei Wei same-restaurant sales results were hampered in the first quarter by the fallout from an identity theft investigation focusing on Pei Wei employees in Arizona.  According to management, the company will now be rolling out E-Verify for all new hires at Pei Wei.  The Bistro already uses E-Verify. 

 

Independent of the impact of the investigation on business in Arizona, there is concern about management’s ability to manage two concepts under one umbrella.  The commentary around continuing soft trends (-3% excluding the -2% impact of the Easter calendar shift) in 2Q did little to raise investor optimism.  In order for Pei Wei to sequentially improve two-year average trends, the concept needs to print same-restaurant sales better than -1%.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - pei wei pod1

 

TXRH

 

Texas Roadhouse is a company that we hold a negative fundamental view of. Traffic compares for TXRH get increasingly difficult over the next three quarters.  Adding price to the menu may have a muted impact on the overall comp given the traffic-heavy nature of the same-restaurant sales number’s composition.  The TXRH core customer is sensitive to gas prices and it is possible that high gas prices during the second quarter, while declining overall since early May, could have impaired the company’s top line.  The stock is trading at a lofty multiple of 8.3x EV/EBITDA, the fourth highest of the casual dining space behind BJRI, DIN, and BWLD. 

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - TXRH pod 1

 

 

BWLD

 

Buffalo Wild Wings is a company that has been performing well over the last twelve months, largely due to extremely favorable chicken wing prices, and same-restaurant sales improved significantly in the first quarter of this year.  The second quarter faces an easy 2Q10 compare of -0.1%.  In order to maintain sequential two-year average trends, BWLD will need to print company same-restaurant sales of at least 4.1%.  Considering that April same-restaurant sales were up +5.3%, and Knapp Track trends in May were stronger than in April, it seems that an acceleration of two-year average trends in 2Q is probable, absent a slowdown in June.

 

COMPREHENSIVE CASUAL DINING TOP LINE SNAPSHOT - kona pod1

 

 

KONA

 

Kona Grill has been a favorite idea of ours in 2011 and, as we wrote in June, the departure of former CEO Mark Buehler was not caused by business-specific factors.  Furthermore, as we wrote at the time, business trends were in line with the company’s expectations and a remodel program coming through in 4Q11 will have a positive impact on comps.  In order for Kona to maintain two-year average trends, same-restaurant sales of 5.4% or better will be required. 

 

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Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 


Gang of Six Plan . . . A Catalyst without Fundamentals

Conclusion:  The Gang of Six proposal will likely pave the way to a debt ceiling extension, but a credible and detailed deficit reduction plan is still a mirage.

 

The stock market’s reaction to the Gang of Six deficit plan was without a doubt positive.  The SP500 ended yesterday up 1.6% and the NASDAQ composite ended up 2.2%.  This reaction was interesting given the credit markets have been signaling that any risk of a U.S. government debt default was minimal based on the fact that credit default swaps for U.S. government debt have not budged this year. The equity markets did, however, rightfully cheer on compromise in Washington, DC, even if default was never realistically on the table.

 

There is no doubt compromise in Washington, DC, especially in these partisan times, is indeed a good thing for America.  While Republican leadership in the House continues to make noise about not being satisfied with the Gang of Six plan, the polls and American voters are shifting away from them.  In the last few days two meaningful polls have been released that likely influenced some in the Republican leadership in the Senate to step away from stalemate on the debt ceiling debate. The key polls were as follows:

  1. CBS Poll on July 18th: This poll from CBS showed that 46% of those polled believed the debt ceiling should be increased and 49% were against it.  Almost a month earlier, CBS ran the same poll and only 24% of those polled believed the debt ceiling should be raised and 69% were against it.  Clearly, on some level, the dramatic shift amongst Americans as it relates to the debt ceiling is influencing a Republican willingness to compromise.
  2.  Gallup Poll on July 18th: The key question asked in this poll was: “What would you like the people in government who represent your views on the debt and budget deficit to do in this situation?” Interestingly, in line with the shift noted in the CBS poll mentioned above, 66% of those polled indicated they would like their political representative to agree to a compromise plan, even if it is a plan they disagree with.

Given the shift in national sentiment it is likely not surprising that the Senate has come to a compromise and that is, as the equity market indicated, positive on the margin, at least in the intermediate term.  Conversely, last night the more conservative House, influenced by the Tea Party, passed a $6 trillion deficit reduction bill with a constitutional balanced budget amendment.   This piece of legislation has been dubbed “Cut, Cap and Balance”.  In contrast to the Gang of Six plan, which has been lauded by President Obama, the House bill is very unlikely to find support in the White House.

 

In reality, passing “Cut, Cap and Balance” was likely more of a symbolic move.  House Majority Leader Eric Cantor signaled as much when he stated the following about the Gang of Six proposal:

 

“This bipartisan plan does seem to include some constructive ideas to deal with our debt.”

 

This seems to imply that Cantor is ready to dance, which isn’t surprising given the polls are shifting away from him.

 

Our core issue with the Gang of Six proposal is its gross lack of detail, which potentially makes the ability to successfully implement the plan challenging.  The key points in the five page memo are as follows: 

  • Cutting $500 billion in discretionary spending over 10 years, including defense;
  • New discretionary spending caps through 2015;
  • Requirement of congressional committees to produce legislation within six months that finds billions in savings in entitlement programs over 10 years;
  • Creation of a 67-vote threshold to make it difficult for the Senate to exceed its spending caps;
  • Overhaul of the tax code, eliminating many tax breaks and using the savings to reduce marginal income tax rates;
  • Elimination of the $1.7 trillion Alternative Minimum Tax and the $298 billion Sustainable Growth Rate formula for Medicare (known as the “doc fix”); and
  • An overhaul of Social Security.

Interestingly, this may be a way of kicking the can down the road on a grand scale as the Gang of Six plan will be utilized to extend the debt ceiling, but the real work on implementation and legalizing will come at the committee level and over a longer period of time, perhaps years.

 

In the Congressional Budget Office’s current baseline case from January 2011, the combined federal budget deficit from 2011 to 2021 is $6.9 trillion.  Currently, Medicare, Medicaid and Social Security combine for 42.4% of annual federal budget outlays.  By 2021, as outlined in the table below, these three programs will combine for more than half of federal budgetary outlays.  In total, by shifting from 42% of federal spending in 2012 to 50%+ of federal spending by 2021, the combined programs of Medicare, Medicaid and Social Security are responsible for contributing an incremental $2.3 trillion to the deficit.

 

Gang of Six Plan . . . A Catalyst without Fundamentals - 1 

 

The math is pretty simple, if we want to solve the deficit problem, we need a credible plan to reduce future healthcare and social security spending.  Without further detail on how this is going to be effected, it is difficult to get very excited about the Gang of Six proposal from a longer term prospective.  In the shorter term, this plan will likely allow the debt ceiling to be extended.  As far as being a credible deficit reduction plan though, the devil is in the as of yet unseen details.

 

Daryl G. Jones

Director of Research 


LIZ: Kate Does Asia

 

Now that the plausibility of LIZ jettisoning its ailing Mexx division is an increasing reality, we can’t help but think that people will start to look more closely at other pieces of the puzzle.

 

LIZ previously announced a Chinese JV that was literally lost by all the noise around this name. For those of you who are doing the deeper-dive analysis on LIZ (which we strongly recommend), here’s our analysis around this JV. Is it an absolute game changer? Probably not. But after doing the math, it turned out to be bigger than we initially suspected (over $0.20 in EPS run rate within 5-years – big for a company that’s currently losing money).

 

The Facts:

- LIZ has formed a new JV with E.Land, a Korean fashion company, to accelerate growth of Kate in mainland China

- the company has reacquired its Kate Spade business in China from Globalluxe starting June 1st, 2011 – at no cost

- The Kate Spade brand currently has 70 full price; 8 outlet stores in Asia (includes Japan roughly 50% of count, 5 stores in mainland China and SE Asia locations)

- Expects to grow Points Of Distribution in mainland China from 5 to 300 by 2020 = ~30/yr on average, but will ramp from ~10/yr initially (~5 in 2011)

      • PODs include mall stores, free standing, and shop-in-shop locations

- Company plans to also reacquire is SE Asia business in 2014

 

Financial Implications:

- The prior structure was a distributor agreement whereby LIZ sold to Globalluxe on a wholesale basis

- The new structure will be to sell to the JV on the same wholesale basis (no change in revs to Kate), but LIZ will also realize a share of the profits/losses from the JV – realized in the “Other Income Line” in the P&L

 

- Of Kate’s ~$180mm in 2010 revs, retail and wholesale account for a 70/30 split respectively

- approximately 15-20% of revs were int’lly-based = $28mm-$36mm, the majority of which was Asia

      • Assuming Asia accounts for 75% = $20mm-$28mm
      • Assuming $8-$14mm is Japan; the rest is mainland China (probably only $2-$4mm) and SE Asia $6-$12mm

- Under the current JV agreement, LIZ and E.Land share start-up store costs based on their proportionate share. This costs are similar to the current U.S. structure:

      • ~2k sq. ft. store
      • ~$350/ sq. ft.  initial capital costs
      • = ~$700k / store (shop-in-shops are considerably less, typically under $100k)

- The following EPS impact is based on the beginning number of stores (5) and assuming a blended rev/store since the POD locations include mall stores, free standing, and shop-in-shop locations. Current Revs/Retail Store are $1.7mm per store based on 2010 results – our estimates suggest that ramps to $2.5mm per store in 2011. We assume $0.8mm-$1.0mm per store for our calculations below.

 

LIZ: Kate Does Asia                                                                     - LIZ JV Total EPS Imp

 

LIZ: Kate Does Asia                                                                     - LIZ JV China1

 

LIZ: Kate Does Asia                                                                     - LIZ JV China2

 

 Contribution Forecast from Kate Spade China pre-deal:

 

LIZ: Kate Does Asia                                                                     - LIZ JV China3

 

Casey Flavin

Director

 


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SLOTS: MAKING THEIR QUOTA

Coincidence that slot suppliers post market share gains in their fiscal 4th quarter?

 

 

Two of the big 3 slot suppliers—WMS and BYI—will be reporting their fiscal year-end quarterly earnings in the next couple of weeks (IGT’s fiscal-year end is in September).  Funny how the slot suppliers seem to produce market share gains in their fiscal year-end quarters (FEQs).

 

As the chart below shows, slot suppliers generally post sequential increases in units sold and market share gains in FQ4 followed by declines in the next quarter (FQ1).  WMS and BYI generated increases of  10% and 23% QoQ on average, respectively in the FEQ.  In terms of ship share, WMS and BYI both on average gained share QoQ in the FEQ.  Interestingly, Konami is the most striking example as its FEQ units sold ballooned on average 31% relative to the previous quarter and its ship share is 5% higher QoQ in the FEQ.  We also see a large drop in share in the quarter subsequent to FEQ for all slot suppliers and a drop in volume for all suppliers except IGT.  

 

SLOTS: MAKING THEIR QUOTA - FEQ

 

So what’s the deal?  There seems to be some speculation that WMS was aggressive in June with discounting to try and make the quarter.  We actually think it’s more likely that their sales force – every supplier’s sales force for that matter – pushed slots out the door to make their own quota.  We are doubtful that Scott Schweinfurth would be pushing discounts to make EPS, especially given how low sentiment and expectations are currently for the group, and particularly WMS. 

 

Keep the FEQ phenomenon in mind next time analysts/investors get excited about quarterly market share shifts.  


Shorting Spain, EWP

Positions in Europe: Short Spain (EWP); Short Italy (EWI); Short EUR-USD (FXE); Short UK (EWU)

 

Keith shorted Spain in the Hedgeye Virtual Portfolio on a rally in the etf EWP today. As a reminder, Spanish risk signals are flashing due to steep debt maturities in August and October (see chart below); mounting political pressure for early elections of Zapatero’s government (scheduled for March 2012); and ongoing concerns about the strength of its banking industry, including exposures to the PIIGS (note: EWP is highly levered to financials, composing 41% of the etf).

 

Shorting Spain, EWP - 1. H

 

To the latter point, Josh Steiner and Allison Kaptur of our Financials team have done excellent work quantifying the most exposed European banks to the PIIGS based on the results of the EBA’s EU Stress Test, which they’ve included in a recent piece titled “European Debt Crisis: Where the Bodies are Buried (the 14 Most Exposed EU Banks)”.  If you didn’t receive a copy, please email us at . In the report you’ll note that Spanish banks rank high in the categories of both total exposure to the PIIGS and exposure as a % of Core Tier 1 Capital.

 

Shorting Spain, EWP - 2. H REAL

 

Below is a chart of the Spanish equity index, IBEX 35, which is broken across both its immediate term TRADE (9,969) and intermediate term TREND  (10,426) lines. As a reminder, despite all “best efforts” of European leaders to come up with solutions to the regions's sovereign debt contagion, we think that if anything should come of the EU Summit meeting tomorrow, which plans to discuss a second bailout for Greece, it will at best be just another short-term band-aid to provide temporarily relief.

 

Spanish risks will by no means come off the table.

 

Shorting Spain, EWP - 2. H

 

Matthew Hedrick

Analyst


WEEKLY COMMODITY MONITOR: CAKE, TXRH, DPZ, JACK, CMG, TXRH, SBUX, MCD, PEET, GMCR

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.

 

WEEKLY COMMODITY MONITOR: CAKE, TXRH, DPZ, JACK, CMG, TXRH, SBUX, MCD, PEET, GMCR - commod 720

 

 

Cheese

 

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.

 

WEEKLY COMMODITY MONITOR: CAKE, TXRH, DPZ, JACK, CMG, TXRH, SBUX, MCD, PEET, GMCR - CHEESE PRICE

 

  • 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.

 

 

Coffee

 

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.

 

WEEKLY COMMODITY MONITOR: CAKE, TXRH, DPZ, JACK, CMG, TXRH, SBUX, MCD, PEET, GMCR - coffee price

 

  • 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.

 

WEEKLY COMMODITY MONITOR: CAKE, TXRH, DPZ, JACK, CMG, TXRH, SBUX, MCD, PEET, GMCR - live cattle price

 

 

  • 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

Analyst

 


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