The commodities we follow in our commodity monitor, on average, went higher over the last week although the most important items were flat-ish.
A stronger dollar would do a lot to relieve cost pressure for food, beverage, and restaurant companies. This past week, however, saw the majority of names move higher. Specifically, Sugar, Chicken Breast, Rice, Pork and Beef moved higher.
The table below details the price action in commodities.
Coffee
Coffee continued its slide downward this week, declining -1.6% following a -8.9% slide last week. News emerging that Brazil, the world’s largest producer of the commodity, may reach a record level next season on favorable climate conditions are helping ease supply concerns. Further supply increases are likely necessary to bring the price of coffee down to more “normal” levels; growing demand from international markets is catching investors’ attention. Countries like Vietnam, Brazil, and Colombia are seeing increasing domestic consumption.
The coffee concepts in the US are seeing tremendous growth and DNKN’s IPO is a sign of that. If coffee costs were to come down from here to more normalized levels, it would be an intermediate term positive for SBUX, PEET, DNKN, GMCR, CBOU, and THI. 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: 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. New coffee consumers are entering the market place and a “new normal”, albeit likely lower than April’s peak, may be reached.
- 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 roughly $2.50. 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.
Cheese
Cheese prices are sky-high at the moment and caused DPZ management to raise guidance for its full year 2011 food basket to 4.5%-6% from 3%-5% yesterday. We continue to believe that others (like CAKE) will have to follow suit. Below is a selection of comments from management teams pertaining to cheese prices from recent earnings calls.
- DPZ (7.26.11): “Given higher than originally anticipated cheese prices, we currently expect our overall market basket for 2011 will increase by 4.5% to 6% over 2010 levels. This was up from our previously communicated range of 3% to 5%.” Hedgeye: Last week we highlighted the fact that DPZ’s last earnings call took place during a trough in cheese prices and we expected a change in tone from the commentary in early May. CAKE is likely, in our view, to make the same transition in tone at some point this year.
- 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.
Corn
Corn prices are continuing to trade largely sideways since mid-July despite Goldman cutting its forecast for U.S. corn production and highlighting “upside risks” in price . Higher corn prices would support higher protein costs. At the same time, however, it is worth noting that the increased number of cattle being slaughtered due to the increased costs of maintaining cattle in the current drought that is marring much of the country’s farmland may also decrease demand for corn prices. Below are two comments on corn prices pertaining to corn. CMG has a contract on corn and MCD is seeing strong enough comps that it was able to maintain its commodity basket inflation guidance of 4-4.5% in the U.S. for the year.
- 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: MCD is driving top-line trends so well that commodity cost concerns are being pushed aside. Additionally, the stronger sales of the higher-margin beverage product helps offset any inflationary pressure from other COGS.
Howard Penney
Managing Director
Rory Green
Analyst
