Rising Commodity Costs Vs. Pricing Power: CMG, WFMI, PNRA, SBUX

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In a November 11, 2010 article titled “QE2 and the future of the United States Economy”, Thomas Kee Jr., President of Stock Traders Daily, foreshadowed one of most talked about concerns regarding the U.S. economy today. Specifically, in the article, he commented that, “If the government continues to siphon money it will reduce the velocity of real money, and prevent real inflation. Instead, the inflationary pressures will be solely commodity based.”

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That is precisely what is happening today. On February 17, CPI data was released, indicating that core consumer prices were only up 0.2% month-over-month, and up 1.0% from a year ago. While those numbers don’t appear to be overly alarming, quite a different story has emerged in commodities such as crude oil, cotton, dairy, wheat, corn, coffee, and a number of others. Most everybody is fully aware of the spiking oil prices due to the stream of troubling headlines coming from the Middle East, and simply from visiting a local gas station. But, the sharp rise in wheat, for instance, hasn’t garnered the same attention. With wheat up about 18% from the beginning of December – and higher prices expected – there is no doubt that the increase will be felt by businesses and consumers alike. With this in mind, we wanted to take a look at a few food-related stocks that have traditionally held pricing power, but may feel the pinch this time around.

Will CMG Be Grilled?

During Chipotle Mexican Grill’s (NYSE: CMG) third quarter conference call on October 21, the company commented that it was mulling over price increases on some items on its menu. CMG felt as if it had accumulated enough good will with its consumers to do so, since it hadn’t raised prices over the past year while many of its peers did. Unfortunately for the company, rising food costs have forced it to change its tune.

In its most recent quarterly conference call, on February 10, its management said that it will hold off on increasing menu prices until the second half of the year even though it expects inflationary pressures to worsen before they get better. At that time, CMG predicted that FY11 food costs will climb in the mid-single digit range. As commodities like wheat, cheese, avocados, and beef rise, it is possible that CMG will need to ratchet up those expectations. With the company standing pat on its own prices, it stands to reason that its margins will be pressured in coming quarters, and so too will its earnings.

The Street is currently expecting strong EPS growth in 1Q11, estimating profit growth of 83%, but analyst estimates will need to be closely monitored as we head through the quarter. Additionally, from a technical perspective, the stock may be vulnerable to further declines – CMG is down ~11% since Feb. 11. Therefore, before entering a position, we urge our readers to first review our trading report to learn about all the key entry and exit points on the stock.

“Organic” Growth May Be Sustained

Whole Foods Market (Nasdaq: WFMI) is coming off an incredibly strong fourth quarter report on February 9 which helped popped shares to the highest level since November of 2006. It was a “beat and raise” quarter, also highlighted by same store sales growth of +9.1% -- its best mark in over four years. The impressive results were heralded as another indication that the economy was picking up more steam, given that it’s an “upscale grocer” with premium prices.

Interestingly, when discussing its 7-9% same store sales growth guidance for FY11, the company stated that the upper end of that range allows for “the likelihood of some positive impact from inflation.” This indicates that the company believes it has the capability to pass along higher food costs to its customers. It is also an indication that its negotiating with its suppliers is going, perhaps, better-than-expected. Another positive attribute that WFMI benefits from is that its customer base is characteristically loyal and in many cases, is willing to absorb higher prices to purchase organic or locally-grown goods.

In my opinion, WFMI is more capable in absorbing rising commodity costs than many food-related companies. Its recent stock performance suggests that may indeed be the case, too. Since reporting its better-than-expected Q4 results, the stock has held most of its gains.

Pricey Menu, Pricey Stock

Another stock that is coming off a “beat-and-raise” quarter is bakery-café Panera Bread (Nasdaq: PNRA). This company has done remarkably well controlling costs, and has pushed its operating margins higher (+130 basis points in Q4) primarily due to tight lids on labor expenses. Its same stores sales growth has been solid as well, clocking in at +5.8% last quarter, partially attributable to retail price increases of 2%. On its conference call, PNRA stated that it will push through another 2% price increase this year.

This is where some concern comes into play. Does PNRA have enough pricing power to increase prices again? Two percent isn’t a large amount, but, in my viewpoint, PNRA is already pushing the envelope as a sandwich and soup chain. As an anecdote, I took my family of four -- which includes two toddlers -- to a Chicago-area location last week and spent close to $30 for lunch. Maybe I’m being a bit frugal, but, when considering all the other sandwich/soup alternatives in the area, this seemed to be quite high. Knowing that PNRA is tacking onto those prices, I will probably choose other options.

That’s not the only pricing issue, I see, however. With a trailing P/E of 32.3, shares of PNRA are on the expensive side. So far, the stock has remained firm, hanging onto a majority of its gains following its Q4 results despite a downgrade and target cut on February 14 from Raymond James. Trading just off all-time high levels, PNRA may be susceptible to a snap-back, especially if commodity price concerns mount. With that in mind, readers should access our trading report on PNRA to discover what price points may offer profitable opportunities.

Growth Brewing In Single Serve Market

Starbucks (Nasdaq: SBUX) is another major discretionary food chain that is highly exposed to rising commodity costs – namely, coffee, of course. The price of coffee beans has also been shooting higher lately as supply stockpiles have dropped, coupled with escalating demand. Unlike the other companies we discussed, SBUX most recent quarterly report and guidance was not overly impressive. In particular, its downside Q1 and FY11 EPS guidance was troubling. The company did not sugar coat the impact that rising coffee costs were having, stating that commodity costs may have a $0.20/share unfavorable effect on EPS in 2011. It is worth noting, though, that on its conference call, it commented that it did not believe the coffee price growth was sustainable.

While SBUX has been hurt more than most, the company also has one of the more intriguing growth catalysts ahead. On February 14, it was reported that SBUX is entering the single-cup coffee market, and is working on a new product for single-cup coffee machines. This has been a hot spot in the coffee market over the past couple of years with many coffee suppliers adding their product to the K-Cup (Keurig) lineup. SBUX has already made significant strides in this endeavor, announcing on February 15 that it entered into an agreement with Courtesy Products to provide its ground coffees for use in its hotel room brewing systems.

Considering the premium prices it already charges, there is little SBUX can do to thwart the rising coffee prices in terms of passing along the costs to consumers. But, its entrance into the high-growth single-cup market may be a great alternative to keep its growth rates churning higher in the face of these inflationary pressures.