- Street estimates have come down considerably since my 6/27/08 posting “NOT BEARISH ENOUGH, NOT EVEN BEARISH”. The second chart shows the trend of declining estimates. We applaud the more realistic estimates. However, analysts continue to project positive RevPAR and flattish margins in 2009. Lodgers will be lucky to show flat RevPAR in 2009 which translates into some serious margin compression. So I have to ask again; Are analysts bearish enough?
Securing accurate data for Leather prices can be tricky –we extrapolated the price data on the attached chart from US government figures covering exports of raw (un-tanned) cattle hides to China (the world’s largest importer). We calculate only a modest raw cost increase -roughly 25% since 2002. While the cost of transport and processing have increased dramatically due to rising oil costs and increasing environmental controls for tanners, we’re still looking at around a 10% decline from 2007 peaks.
The US primarily exports hides raw due to the onerous environmental issues attached to operating a tannery. There are so few leather producers operating in the US today that Redwing, the last major domestic manufacturer of leather footwear, owns dedicated tanning facilities to meet internal demand. Interestingly, press reports from China have indicated increased regulation of tanning operations there has led several firms to invest in tanning operations in Africa –notably Kenya.
One note: Much of the finer leather used by producers for brands like Coach are actually of different, higher grades of hide (“wet blue” etc.) than the one charted here. We used the most common grade as our base for calculating the % change since it afforded us the greatest amount of price and volume data depth by far.
- 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.
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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