Restaurants brace for commodities impact

Restaurant operators are braced for dry, stiff headwinds in commodity costs as America’s food-producing regions continue to face the most persistent drought in a half century.

Operators from Krispy Kreme to high-end steakhouses are raising flags about the drought’s effect on wheat, corn, soybeans, and other produce, as well as pastureland, beef and poultry, and the effect it will have on the market basket. And little weather relief is in sight.

The U.S. Department of Agriculture’s Aug. 21 update said: “Serious agricultural drought effects persist east of the Rockies, despite cooler weather and recent showers.” For the week ended Aug. 19, the USDA reported that 51 percent of U.S. corn and 37 percent of soybeans were rated in very poor to poor condition.
 
Jeff Powell, president and chief executive of the 15-unit Razzoo’s Cajun Café, said he expects his Addison, Texas-based chain “will be negatively impacted by the drought and other pressures on grain supply.” 

“Corn particularly is a baseline driver of economics in the supply chain,” Powell said. “A shortage of corn caused by drought or other dilution of supply by other uses (ethanol, etc.) obviously negatively impacts the dynamic. Corn is a necessary feed and source of oil, and when in shortage the impact on beef, pork and poultry prices is immediate.”
                               
John T. Barone, president and commodities analyst for Market Vision Inc., wrote earlier this month that higher wheat prices for bread, pizza crust, pasta, flour tortillas and bakery products “are obvious.”

“The ‘sneaky’ price increase will come from the big bump in corn and soymeal prices," Barone said. "That’s because they are the primary feed inputs for poultry, dairy cows, pork — and this year, cattle, because grazing pastures have also been toasted by the drought,”

Popeye’s Chicken & Biscuits recently pointed to the drought and high prices for corn, which is the main feed source for chicken, as the main cause of its higher costs. The company said commodities prices rose 1.5 percent for the second quarter, and company executives expect a 3-percent increase in food costs for the remainder of the year.

A volatile year ahead

Barone also pointed out that beef prices will see a “boomerang” effect. “Cattle ranchers are liquidating, selling off inventory and breeding stock at an accelerated pace,” he said. “This is currently having the effect of inflating available beef supplies and, as a result, beef prices have been moving lower over the past month."
 
During the company's second-quarter earnings call with investors, Wendy’s executives said they did see some relief on beef costs for the balance of the year, as the price of ground beef is dropping with more cattle being sent to slaughter. Next year, however, is shaping up to be more difficult.

"Come spring of 2013, when seasonal beef demand kicks in, there will be hell to pay," said Barone. "The USDA says beef prices will be 4- to 5-percent higher next year.”
 

Produce prices are also seeing pressures, said Powell of Cajun-inspired casual-dining chain Razzoo’s. “Drought and other negative environmental conditions compromise the vegetable supply chain,” he explained. “Supply brokers scramble to find global sources of basic staples in both hemispheres. A reliable supply of jalapeños from Mexico may dissipate while a more reliable supply may emerge in Chile. … Our produce costs are volatile.”
 
Even companies dependent on a narrower slice of commodities are concerned. Douglas Muir, Krispy Kreme’s chief financial officer, said in a second-quarter earnings conference call on Aug. 22, that “commodity markets have been volatile lately and the effects of the drought have been significant on many products," noting that Krispy Kreme expects costs to rise modestly.

“I should emphasize, though, that next year is a long way off and much can change in volatile times,” he said. “Except for sugar, we have not purchased a significant portion of next year's need and we are therefore looking to lock in attractive pricing for next year whenever we can.” He added that the company is currently purchasing flour and shortening for the first and second quarters of next year.

Planning price increases

Many restaurant companies are considering modest menu price increases to mitigate rising commodities costs.

Powell said Razzoo’s is expecting its basic food costs to increase by 5 percent to 8 percent over the next year. He said that in response, the Cajun-inspired casual-dining chain anticipates a minor price increase, of 1 to 2.5 percent, over the next 18 months.

Stephen Hare, chief financial officer of Dublin, Ohio-based Wendy’s, said in a conference call with analysts on Aug. 9 that the higher beef costs will be the “largest driver” of commodity spending for the 6,500-unit chain. Hare also said the company would make cuts and “implement selective price increases.”

Similarly, Arne Haak, chief financial officer of Ruth’s Hospitality Group Inc., said in July that the Heathrow, Fla.-based chain of upscale restaurants was looking at menu engineering possibilities and “pricing opportunities.” And casual-dining chain Red Robin of Greenwood Village, Colo., said the commodities outlook was forcing the chain to look at “modest price increases.

Execution is a key part of successful price increases, noted James Morgan, Krispy Kreme’s chairman, president and chief executive. “If we do increase prices [we want to ensure] that we are increasing value to our guest and customers at the same time," he said, "and I think the two are compatible.”

In addition, said Razzoo’s Powell, a “fatal response” for operators would be to compromise quality for a lower cost or to cut portions with the hope that the consumer wouldn’t notice.

“I see this as a healthy and heightened challenge to buy and execute better,” he said, noting that the challenge leads operators to “eliminate waste while maintaining value on the plate while also improving the overall service experience of the guest.”

He added, “Solid operators will react to these challenges and will meet what will be a substantial and increasing customer need. Others will be driven from the market.”

Contact Ron Ruggless at [email protected].
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