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HBI: Two Words -- Systemic Change

Is it me, or did HBI's CEO just say that there is a systemic change to cost and pricing dynamics in this industry as it will last beyond 2008? Not news to you, or to me. But this is a massively meaningful change in HBI's public tone. Bad news all around. I think that HBI still has meaningful cost levers which will help it take share in such a climate. I'd hate to be Gildan right now.
There's never been pricing power in this space -- so why start now?

America’s Chicken Crisis!

Two chicken processors reported and for the first 9 months of fiscal 2008, Tyson’s chicken segment and Pilgrim’s Pride have collectively lost $263 million. This trend can’t continue.
  • Pilgrim’s Pride reported a net loss from continuing operations of $48.3 million in 3Q08 and a net loss of $193 million year-to-date, primarily as a result of higher feed costs, which were up 41% YOY in the quarter and are expected to be up $900 million for FY08. Something has to change for PPC! The company has cut back on chicken production to increase prices, but reductions have not yet been enough to cover costs. The average breast meat price in 3Q was $1.47 per pound and prices have already declined 10% since the end of the quarter to $1.33 per pound. Management stated that based on current expectations, breast meat prices need to reach $2.15 per pound just for the company to breakeven. That means prices need to increase over 60% just for PPC to cover its costs. Chicken prices are inevitably going higher.
  • Additionally, Pilgrim’s Pride stated that it is taking steps to shorten the duration of its fixed price sales contracts. It is moving away from its previously standard 1-year timeframe to 90 day contracts. Currently, 17% of its sales are being driven by annual basis contracts, but they will expire as of January 1 and the company has no intention to enter into any new annual contracts at that time.
  • Darden and Sonic have both commented about their decreased opportunities to enter into longer-term contracts, resulting in their having to float more of their key commodity exposures. I wrote about the impact this increased volatility will have on restaurant operators’ income statements on June 25, highlighting that it eliminates some certainty to the restaurant industry’s earnings model.
  • PPC management also stated that it is not seeing customers walk away as a result of these new terms, which indicates that restaurant operators recognize that these shorter term contracts are part of their current reality.
Thank you, Walt Disney for the picture of Chicken Little

TBL: I Still Like The Boot

I’m sticking with my 5/12 post on Timberland “The Bottom of the Boot” that outlines an inflection point in the business model. In this market it is never fun being positive on a name in advance of a quarter, but I think expectations are in check, there are cost levers to pull, and business trends at retail are less toxic than they have been for TBL in recent quarters.

I particularly like TBL’s positioning on the sales/inventory/margin triangulation below. Translation = TBL spent 5 quarters in the worst place imaginable – sales down, inventories up, and margins off meaningfully. Last quarter it popped its head into a part of the grid that signifies much better inventory/sales, which is usually a prompt for GM % to recover. The margin and inventory move estimated below is almost always a positive stock move. Tack on the SG&A saves from apparel outsourcing and retail store closures, and I like how this one is shaping up.

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Separating the Wheat from the Chaff

The bullish data points that spurred the sudden (and short lived) spike in wheat futures in recent sessions seem much less compelling today as initial harvest projections from the world’s third largest producer start to emerge. After several years of bone dry weather Australian farmers are seemingly back on track with July rains helping forecasters project a yield of over 23 million metric tons for this season.

Andrew Barber
Director



Pilgrim Pride’s Comments Mirror Tyson’s

Just as Tyson said yesterday that consumers have not yet felt the effect of higher grain prices, Pilgrim Pride said today that consumers “have just begun to see higher prices for meat and poultry in their local grocery stores.” Meat prices in the grocery channel have not yet moved up as much as other items, such as dairy, produce and cereals.
  • Management stated that production cutbacks have not been enough to cover feed costs. That being said, CEO J. Clinton Rivers said “American consumers should brace themselves for sticker shock at the meat case over the next 12 months.”

Increased Wheat Production In Australia Should Help Ease Prices

Bloomberg reported today that wheat from Australia, forecasted to be the world’s third largest wheat exporter this year (behind the U.S. and Canada) should return to the global market in 2008 after two years of drought. Managing Director of Malaysia's second-biggest miller Teh Wee Chye was quoted from a conference in Melbourne, “Australian wheat is important to us. We expect Australian wheat to come back into the global market in 2008. The current prospect of a huge crop in the northern hemisphere, as well as improved weather conditions in Australia, will lead to an overall improvement in the global wheat supply and result in lower and affordable wheat prices for both producers and consumers. This will bring food inflation to a more reasonable level.''
  • According to the article, wheat output in Australia is forecast to reach 23.7 million metric tons this harvest, up over 80% from last year’s drought-reduced crop of about 13 million tons.

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