BKC – The Commodity Cost Outlook Disconnect

BKC’s 4Q08 5.5% same-store sales growth at its U.S. and Canada division looked impressive at first glance, particularly when you consider the strong 4.8% comparison from last year. But, this solid top-line growth did not translate into restaurant margin growth. Instead, BKC reported a 360 bp decline in company restaurant margins in the U.S. and Canada. Management attributed 200 bps of the decline to higher food, product and paper costs and 130 bps to non-cash expenses related to restaurant reimages (net of the reimaging program, margins would have declined 230 bps).
  • On its earnings call, management commented on its commodity cost outlook, saying “In the fourth quarter, beef cost increased 11% and chicken costs remained unchanged largely due to our multi-year fixed price contract compared to the same period last year. We believe commodity cost peaked last month and it appears over the next six months the general economy is likely to support a decline in food cost…Consequently, over the next six months we expect our commodity costs to decline 2 to 3% from where they are today. But still up 5 to 7% over the prior year. This is our best forecast given the ongoing volatility in the commodity market and what we know today. “
  • This was the first time I have heard any restaurant management team say that they think commodity costs have peaked. For the most part, most companies have said they continue to see prices moving higher so BKC runs the risk of having set expectations that commodity costs have peaked. BKC’s FY09 guidance includes the expectation that company restaurant margins in the U.S. and Canada will be unchanged from FY08’s adjusted level, and management anticipates offsetting its 5%-7% food inflation with strong comp performance and pricing initiatives. BKC will need its favorable commodity cost outlook to hold true for that to happen, particularly with a chicken contract that is set to expire in December.
  • Below are recent comments made by a handful of management teams that I think would disagree with BKC’s favorable commodity cost outlook:
  • June 26 – CKR CFO Theodore Abajian: “Really, I think everybody is starting to see beef prices go up again, with feed prices having gone up. And you know, that’s something that everybody is going to have to deal with. We are going to certainly look at taking additional price increases as needed to offset incremental costs.”
  • July 17 – YUM CFO Richard Carucci: “To your point, John, we don’t know what’s going to happen to commodities but we are planning as if they are going to stay high and what we’re going to try to do is just make sure we don’t get behind on it. You know, quite frankly, this year we went into the year assuming it was going to be $55 million. It ended up being $100 million in the U.S. and we got a little bit behind on pricing.”
  • July 23 – MCD CFO Peter Bensen: “Obviously you hit it that the beef costs will be higher the second half of the year than we experienced in the first half, and again we have a lot of confidence that our supply chain folks will help to mitigate the impact as best they can, but the reality that we are all dealing with is that we expect them to be higher in the second half of the year.” McDonald’s raised its beef cost outlook for FY08 to up 8%-9% (from its prior guidance of relative flat). Management also stated that its dollar menu would look different next year than it currently does due to current cost implications.
  • July 29 – BWLD said they would want to lock in chicken wings at the current prices but that suppliers are not interested (implies that they think prices will be going up).
  • July 28 and 29 - 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’s average breast meat price in 3Q was $1.47 per pound and management stated that based on its 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 for restaurant industry.

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