News emerged today unveiling an agreement between BKC and SBUX to offer Seattle’s Best Coffee in approximately 7,250 Burger King restaurants across the United States by September 2010. This is a positive for both companies.
On their last earnings call, SBUX made it clear that they saw growth potential in the Seattle’s Best Coffee brand. Management stated that its research strongly suggested that SBUX had an “opportunity to position SBC with new customers” and that they “plan to create compelling franchising and distribution opportunities in 2010 and beyond”. SBC is already in Subway restaurants. Starbucks sees SBC as an opportunity to increase its overall share of the coffee market. We believe that the partnership with Burger King will offer an effective vehicle for Starbucks to gain further traction in the market.
BKC stands to gain from the agreement also. For the second fiscal quarter, ended 12/31, Burger King’s traffic grew year-over-year in all day parts except breakfast. In order to compete with McDonald’s during the breakfast day part, it has been clear that a premium coffee program would greatly aid that effort. Serving SBC in Burger King is likely to have a positive impact on breakfast traffic. It was reported that BKC will begin rolling out the coffee brand in the summer to better compete with MCD’s McCafe drinks and be nationwide by September. During BKC’s most recent earnings call, management hinted at upcoming initiatives to address their breakfast offerings, “…we obviously have a lot of activity happening in our pipeline against breakfast. We do have upcoming in April, some breakfast value news that we will be advertising in the market.” Whether or not there is more incremental news regarding Burger King’s breakfast menu, I view this news as a modest positive for the company.
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The Macro Team
Following a breather in early 2010, cotton futures reversed sharply last week up $0.08/lb or 12%. Futures prices are now back up over $0.74/lb, nearing the highs of December (~$0.76/lb.). On recent earnings calls, both Hanesbrands and Gildan noted that their cotton costs were either locked in or hedged through 3Q. However, each of these manufacturers had a different view on what cotton costs may mean for pricing.
While GIL noted that its plan was to not to pass through cost increases, HBI suggested that at a mid-$0.70 range in cotton prices gives the company an option to pass through increases given its success in passing on costs in the past. One thing to note is that HBI still has the benefit of using factory consolidation savings as an offensive weapon to offset commodity costs and by offering a better value proposition to consumers. GIL is out of gas. In addition, with GIL far more exposed to cotton than HBI (~33% of COGS for GIL vs. ~6% for HBI - or ~$0.13 in EPS for each 5 cent move in cotton), the negative implications for rising cotton prices are considerably greater for GIL. Recall that favorable y/y cotton and energy costs accounted for a 950bps increase in gross margins in Q1 for GIL. As a point of reference cotton contributed only 180bps to HBI’s most recent quarter. Needless to say, this will be one of many topics of discussion at HBI’s analyst day next week, which we’ll be commenting on real-time.
The bottom-line here is that while the setup continues to look favorable for both companies over the near-term, either a rebound in consumer demand or a decline in commodity prices will be needed 2-3 quarters out to sustain intermediate-term outperformance – neither of which were supported over the past week.
This quarter should beat consensus and guidance but all eyes will be on guidance for 2010. We’re at $1,385MM of revs and $236MM of Adj EBITDA for Q4 vs. consensus of $1,341MM and $226MM, respectively.
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