PNRA - One of the Most Inflation Sensitive Business Models in Restaurants…….

Panera’s 2Q results reflected positive transaction growth despite a 5.5% retail price increase and operating margins grew YOY for the first time in 11 quarters, partly due to the 5.5% price increase. Panera was successful in sustaining 1Q08’s positive transaction/mix while growing margins, which is typically an indication of a balanced use of price. In the first 27 days of 3Q, however, this balance has already fallen off as transactions are running down 2.4% with retail pricing up 6%. The company is facing huge commodity headwinds in 2H08 and looking out to 2009, due primarily to higher wheat costs and gas prices. Management has set an internal goal to increase margins by 150-200 bps in 2009 off of 2007 levels despite these rising costs, which makes pricing a necessary component of this growth.
The company raised prices by 2.5% in November 2007 and followed that with a 2.7% increase in March 2008. Panera implemented another price increase on its bagels in June and is targeting a 1% increase across the menu in September, resulting in average pricing of 6.5% in 3Q08 and 6% in 4Q08. And, management commented that testing of a new pricing initiative for 2Q09 will take place in 4Q08. Although management stated over and over again that its quarterly value surveys show that the brand’s value perception has not changed since November 2007 when the company became more aggressive with its pricing initiatives, these price increases are concerning as it relates to their eventual (or current as it relates to early 3Q08 performance) impact on traffic trends. Management guidance assumes 1.5% to 2.5% transaction/mix declines in both 3Q and 4Q. On a positive note, Panera’s new breakfast sandwich helped to drive incremental traffic in 2Q while driving higher gross profit per transaction.

The big question going forward continues to be centered on increasing costs. Management has become more proactive in locking in its commodity requirements and is now purchasing its primary commodities six months ahead for a six month timeframe. This allows management to more effectively manage cost volatility. Panera has locked in 95% of its wheat requirements for 1H09 at a favorable price relative to 1H08 levels ($10 per bushel versus an average of $15) and expects to contract its 2H09 costs in 4Q08. Despite this YOY favorability in wheat costs, management is currently forecasting 5%-6% commodity inflation in FY09 with gas prices representing the biggest risk and unknown. It is this commodity risk combined with continuing concerns about the economy which led management to state that relative to the street’s current 2009 EPS growth projections of up 17%-21%, those expectations for growth “greater than 20% are not prudent at this time.”

Reactive Suppliers: MCD and COST Ain't Lovin' It?

McDonald’s and Costco are both flashing negative divergences today, trading down in an up tape. Why? Well, mostly because their margins are under assault by lagging effects of inflation. The stock market is trading up because reported inflation for July will show a sequential downtick from the June highs. These stocks are down because their suppliers are reacting to trailing data.

On their conference call right now Costco is saying that price increases they had assumed they would get from suppliers are larger and more frequent. The upshot is that in the near term, COST will have a much larger LIFO adjustment from inflation.

It’s important to understand that Macro wags the tail of many CFO’s. These guys are rarely early, and mostly late.

COST and MCD are trading down -10% and -2%, respectively.
Its What's Inside That Counts!

Commodity Trends – EYE on Corn

Corn fell to the lowest in almost two months amid speculation falling energy costs will diminish the appeal of commodities as a hedge against inflation and as Japan plans to cut imports of the grain. In sympathy, wheat and soybeans also declined.
  • Japan, which imports more than 60 percent of its food requirements, the highest level among developed countries, wants to become less dependent on overseas grain supplies to protect it from soaring international prices and ensure long-term security of supply, Yuji Sawa, vice minister of Agriculture, Forestry and Fisheries, said in an interview.
  • South Africa, the biggest corn producer in Africa, may increase its forecast for this year's crop by 1.7 percent, according to a Bloomberg survey of grain traders.

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Putin Getting A Headache...

Global stock markets are rising today, and Russia is falling. This is a very straightforward negative divergence that Putin cannot be enjoying. Since my “Fading Fast Money” (Commodities) note on 5/20/08, Russia has lost -15.1% of its value.

Long term support for the RTSI Index is 2133, and today we’re seeing that line broken. As a leading indicator, this does not auger well for energy prices.

It is global this time, indeed.
Chart courtesy of

Spanish Inflation Consensus

Make no mistake, the “global inflation” Trend is a consensus one. Spain reported their June PPI numbers this morning at +9% year over year. That was a 23 year high. Given that stocks are discounting mechanisms of future news, it should be no surprise to the revisionists out there at this point that the Spanish stock market ended up losing almost 1/3 of its value from its October 2007 peak (when inflation was not consensus).

The “Trade” here in global equities is that inflation is abating sequentially from its June 2008 peak. Yes, inflation remains elevated, but that’s not the point. The point is that once you’re reading the July inflation reports, they’ll have come down from June.

Jean Claude Trichet and the ECB are going to start to look a lot smarter by the day. They stepped up, raised rates, and quelled inflation… for now.

Asian Central Banking: Ben Bernanke, Take Notes...

Weakness in Asian currencies was one of the stealth leading indicators of their 2008 economic growth slowdown. This week that “Trend” has started to reverse itself. The Indian Rupee has recovered, predictably, since Singh surviving a political confidence vote. Meanwhile the Philippine Peso had its biggest one day move in the last 7 years overnight, trading +1.3% to back up to the 44 level.

Central bankers in Asia have been proactively hawkish, fighting the good fight on the inflation front. With commodities correcting this week, they’re getting rewarded for their travails. The head of the Philippines central bank came out with explicit comments overnight that he needs to raise rates further. His domestic stock market and currency liked that, and rallied. South Korea’s new President has recently done the same. Korean equities traded up another +2% overnight.

Ben Bernanke, I hope you’re taking notes.


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