Restaurants: Commodity Prices Becoming More Worrisome

Deutsche Bank says, “The opportunity set for global, integrated agribusiness processors has markedly improved with the shortfall in FSU grain production. Though global stocks-to-use for wheat are adequate, the U.S. should gain a greater share of trade. Corn exports are also benefiting as a replacement for wheat in livestock rations. This should also aid soybean meal demand. New crop corn export orders have been strong, as customers wait for the better quality crop. At the same time, non-GMO corn is moving from Brazil to the EU. We expect both Archer-Daniels Midland (ADM) and Bunge (BG) to benefit from these trends. While higher and more volatile grain prices are typically negative for protein processors, we view the current dynamic as positive for Smithfield (SFD).” “Many key commodity costs (proteins, dairy, wheat) have been moving higher in recent weeks and some were already at elevated levels versus last year. Food costs in aggregate represent about 35% of the cost base for most restaurant chains. While we do not see much commodity-related risk to earnings forecasts in the near term, as most chains have already locked in major items for the balance of calendar 2010, we do see some risk to 2011 as prices for most major commodities are well above the levels seen in mid-to-late 2009, which is when many contracts were likely signed. Each 1% change in food costs impacts annual EPS by 2-3% for the avg. restaurant chain and margins by ~30bps. Restaurant companies expect ~1% food cost deflation in FY10. If this were to rise to just +2% in FY11, the earnings pressure could be 7-8% (before factoring in menu pricing). That said, initial 2011 food cost guidance, from companies that have offered color so far, are only up about 1% on avg. However, this could change as chains are just now entering the key period for food contract negotiations,” the analysts add. More Analyst Ratings here