Over the last week, continuing dollar strength put pressure on commodity prices. Brent crude oil went higher, despite the greenback strength, suggesting that the slow-but-steady decline in gas prices could be plateau-ing.
Commodity prices declined across the board, with only chicken wings gaining on the week. Wheat, coffee, cheese and corn fell -7.1%, -3.8%, -3.6%, and -2.8% respectively. On our commodity performance table, below, the most interesting thing is that there are now several commodities trading below their year-ago prices. Cheese, in particular, is surprising given where it was trading just a few weeks ago. Caution is warranted on dairy prices, however, given that the fourth quarter compare becomes more difficult as time goes on.
Coffee prices declining over the last week is a function of the stronger dollar, which erodes the appeal of commodities as an asset as it gains. From a supply and demand perspective, coffee exports from Colombia, Mexico, and seven other Latin American countries fell 13% in August from a year earlier. Total shipments dropped to 1.545 million bags from 1.766 million bags, Guatemala’s National Coffee Association, or Anacafe, said in a report released yesterday.
Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls.
PEET (8/2/11): “As we indicated, in our first quarter call, we had to buy a small amount of our calendar 2011 coffee beans at significantly higher prices and this coffee will roll into our P&L during the third and fourth quarter.”
“Higher priced coffee resulted in gross margins this quarter being 290 basis points below prior year. In our first quarter conference call, we indicated that in addition to the overall higher price coffee market, we had to buy a small amount of coffee this year at significantly higher prices. And as a result, we expected our coffee cost to be 40% higher in fiscal 2011.”
HEDGEYE: Peet’s is a company with a very competent management team that manages coffee costs extremely well. Its higher-end, loyal customer base makes the price elasticity of demand more inelastic than for other coffee concepts’ products.
SBUX (7/28/11): “As I mentioned earlier, are absolutely a headwind for us in the full business and that's most acutely impactful on margins in CPG as it's a much more coffee intensive cost structure, as you know. I can tell you that the decline as I spoke about it earlier from about 30% operating margin in CPG this year down to the target 25% next year is really all explained by commodities. Absent commodity inflation we'd be at or improving our margin in the coming year.”
“As we had anticipated, in recent weeks, coffee prices have retreated significantly from a high of more than $3 per pound just a couple of months ago to levels now near $2.40 per pound. As prices have been falling we continue locking up our needs for fiscal '12 and now have virtually the full year price protected.”
HEDGEYE: Starbucks is aligning itself with the right partners to gain more control of its coffee costs to provide investors with more certainty going forward and to protect its margins as global coffee demand continues to rise.
GMCR (7/27/2011): “However, what we've said is that should coffee prices or other material costs spike, we will certainly consider price increases as necessary. We certainly hope that we do not have to cover one again next year. But our objective long-term is attempting to maintain our gross margin as we would see input costs come along.”
HEDGEYE: GMCR hedges out 6-9 months in advance. Strength in the dollar has helped bring coffee prices lower but whether or not dollar strength will continue or not will be a significant factor in future price action in coffee. Growing demand, globally, is bullish for coffee prices over the long term.
CORN & WHEAT
Grain prices slumped over the last week, again, as a result of the stronger dollar. Continuing concerns surrounding crop sizes in the U.S., Ukraine, Argentina and Australia are providing some price support while rising inventories and the strong dollar provide downside pressure. Despite concerns around the crop size, we would expect a continuation of slow growth and a stronger dollar to prevent significant upswings in price. Wheat prices also fell on dollar’s rally cutting export demand.
Below is a selection of comments from management teams pertaining to grain prices from recent earnings calls.
PNRA (7/27/11): “Just to note on the cost of wheat, in 2011 overall, the per-bushel cost will be about the same as 2010 due to our laddering purchasing strategy.”
“We are going to take price in the fourth quarter. This price will offset dollar for dollar the per-bushel inflation of wheat of approximately $3 a quarter that we're going to see in the fourth quarter of this year and then across next year”
“We do continue to expect significant inflationary pressures in 2012, 4% to 5% food inflation, $10 million of unfavorability on wheat costs, which means that we don't expect operating margin much better than flat to full-year 2011 in 2012.”
HEDGEYE: Wheat costs have come down but it remains unclear whether or not the current easing of grain prices will continue. Weak global demand and a stronger dollar are currently trumping the adverse impact on supply due to weather and fires in the U.S. Slowing demand may also mean lower sales for PNRA, so it remains to be seen if margins improve from this effect, even if high wheat costs come down.
DPZ (7/26/11): “We're fairly locked in on our chicken, locked in on our wheat into – partway into next year.”
PZZA (8/4/11): “We're actually covered through Q1 from a contract standpoint. So from a supply chain disruption or even significant price impact we don't anticipate anything between now and the end of the year.”
Cheese prices have dropped dramatically since early August and are now trading below the year-ago price. This is the first time cheese prices have been down year-over-year since January. It is important to note that the bullish supply and demand set up for beef prices could indicate some support for cheese prices as compares become more difficult in the fourth quarter.
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: We recently 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's EPS guidance may seem more reasonable now but we would caution against making that assumption if it is based on diary inflation being benign. Beef prices and dairy prices, naturally, track rather closely and dairy prices have whipped around to the upside and downside this year. Tougher compares as we move through 4Q only adds to the uncertainty.
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. Cheese was a contributor to a cost of sales increase in 2Q11, as we predicted. For the remainder of the year, barring another (possible) spike in prices, TXRH could see some margin relief from lower dairy costs.
CMG (4.20.11): “As we move into 2011, we're expanding our use of cheese and sour cream made with milk from cows that are raised on open pastures rather than spending much of their time in confinement, as most dairy cattle do.”
HEDGEYE: For CMG, the lower levels of dairy costs, if they persist, will offer some food costs relief on the company’s P&L.
Chicken wing prices gained 7.2% over the last week as the price action continues to point higher. Unless there is a significant upswing into year-end, we expect favorable year-over-year compares to continue until 1Q12.