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Takeaway: In our opinion, the new Farm Bill suggests dairy prices are likely to remain elevated in 2014.

We added CAKE to the Hedgeye Best Ideas list as a SHORT on 1/16/2014 at $47.51 per share.

 

DAIRY PRICES REMAIN ELEVATED 

Today, the House passed and sent to the Senate a new five-year Farm Bill that included an overhaul of dairy policy that is, on the margin, bullish for dairy prices.  The bill did not, however, include the proposed stabilization program which was intended to mandatorily curb production in periods of oversupply.  While this stabilization program would have been wildly bullish for dairy prices and our short thesis on CAKE, our 2014 estimates correctly assumed it would not pass.

The measures introduced are intended to limit how much future milk production can be insured and is expected to disincentive dairy farmers from producing excess milk.  Despite falling short of the most aggressive expectations, The National Milk Producers Federation is pleased with the bill and the benefit it will provide to dairy farmers.  This is largely supportive of our call for higher dairy prices in 2014.  Highlighted by the two charts below, milk and cheese prices continued to climb over the past week and are now up 16.4% and 41.0% on a year-over-year basis.

CAKE: DAIRY PRICES RISING - chart1

 

CAKE: DAIRY PRICES RISING - chart2

 

CAKE: DAIRY PRICES RISING - chart3

The last time dairy prices were up this much on a year-over-year basis was in the middle of 2011, when CAKE’s cost of sales growth increased substantially.  Currently, consensus estimates are for cost of sales growth of +0.15% and +0.27% in 1Q14 and 2Q14, respectively.  In our opinion, these estimates are too low and fail to take into account a sustainable rise in dairy prices.

Evidenced by our earnings sensitivity analysis, any upside surprise to these numbers would have a notably negative gross impact on earnings in 2014.  We expect management will be rather limited in their ability to offset rising dairy costs with price, due to the declining traffic trends the company is facing.  To this extent, we believe management will have to lower their FY14 earnings guidance and, subsequently, street estimates will be revised down.

CAKE: DAIRY PRICES RISING - chart4

 

CAKE: DAIRY PRICES RISING - 1 29 2014 11 26 23 AM

 

 

Feel free to call with questions.

 

 

Howard Penney

Managing Director