Soaring Beef Prices: 3 Stocks to Feel the Bite - Analyst Blog

Demand and supply is the backbone of a market economy as demand for a commodity and its supply determine the market price. Increase in demand for a commodity is always good news for producers, whereas limited supply of the same results in increased prices for customers.

Currently, beef prices are soaring and have hit their highest level in almost three decades. Prices of milk, eggs fruits and vegetables are climbing gradually. This is due to a severe drought in most parts of California, a major producer of these staples, which affected the produce and compelled farm owners to sell off their herds owing to lower feed supplies.

The average retail cost of fresh beef has climbed to $5.28 per pound – the highest since 1987 – due to a declining cattle population and growing export demand from countries such as China and Japan. In fact, the demand for U.S. beef has increased exponentially in overseas markets, especially in Asia.

According to the U.S. Department of Agriculture, food prices in the country are expected to increase in the range of 2.5% to 3.5% in 2014 on beef, poultry and egg price increases.

Given the highly cost-sensitive nature of the industry, it often becomes difficult for food companies to immediately pass on the burden to customers. This is what worries investors. Though higher prices may translate into higher revenues, it may come at the cost of a significant drop in profit margins.

Though it is difficult to pinpoint retail/wholesale stocks that would be hurt by the increase, we have identified a few likely to be affected by the surge in beef prices.

Bloomin' Brands, Inc. BLMN offers beef products at its Italian as well as casual dining restaurant. Proteins account for 60.0% of the total commodities purchased by the company, out of which approximately half of the total purchased protein is beef. In the last quarter, costs of sales of the company increased mainly due to an increase in beef prices. This Zacks Rank #4 (Sell) company has guided beef inflation in the range of 3.0%-5% for 2014.

Red Robin Gourmet Burgers Inc.'s RRGB menu features a host of gourmet burgers made from fresh ground beef and other products. In fact, it recently added a new premium half pound burger -- Red Robin's Finest -- to the menu, made from 100% Angus beef. Ground beef accounted for 14.0% of its total cost of sales in 2013. The company expects beef costs to increase in the range of 4.0% to 5.0% in 2014. Red Robin Gourmet presently has a Zacks Rank #2 (Buy).

In fiscal 2013, beef costs represented approximately 40% of the food and beverage costs of Ruth's Hospitality Group Inc. RUTH, one of the leading restaurant companies. This Zacks Rank #2 company expects beef inflation in the range of 4.0% to 8.0% in 2014 and expects beef prices to hurt earnings in the first quarter.

The recent jump in beef prices could result in higher-than-expected cost increases for these restaurants, thereby pulling down profits further.

Conclusion

Most of the analysts continue to expect a rise in food prices for the rest of 2014. Food costs account for about one-third of restaurant sales, thus making the industry vulnerable to food cost inflation. With Easter holiday coming up, inflating beef prices would hurt customer visits if the cost burden is passed on to them.

Apart from core restaurant industry stocks, soaring beef prices are also likely to affect meat processor Tyson Foods, Inc. TSN. Beef is the primary raw material for this company, which has been registering higher profits on increasing sales of beef and chicken for the past 2-3 quarters.

However, it is difficult to predict the extent to which increasing sales would mitigate the impact of rising beef costs going forward. Rising beef costs would start affecting volumes as and when the price increase is passed on to customers. This S&P 500 company expects a year-over-year reduction of 2.0%-3.0% in industry fed cattle supplies in fiscal 2014.

Some other casual and full service dining restaurants like The Cheesecake Factory Inc. CAKE, Chipotle Mexican Grill, Inc. CMG, Darden Restaurants, Inc. DRI, The Wendy's Co. WEN, Texas Roadhouse, Inc. TXRH and some fast food hamburger restaurants like McDonald's Corp. MCD and Burger King Worldwide, Inc. BKW could also be adversely impacted by the rising prices.

Moreover, the brunt of government budget cuts, higher gasoline prices, payroll tax increases and delayed tax refund checks leave less room for consumer companies to pass on the rising food costs to customers, thus pressurizing profits.

It's high time that these food chains focus on strategies that will help them alleviate the impact of increased costs. Implementing the right pricing strategy, increasing global presence and focusing on supply chain revenues may as well save the day for these restaurateurs.