Milk Could Sour These 8 Companies' Profits

To celebrate the holidays, we here at the Fool are devoting extra virtual ink to all things consumer-focused in a special section called "The 12 Days of Christmas." Over the coming week, we'll have our "12 Days of Content" surrounding consumer-focused names that look set to profit or perish from the holiday cheer.

In the classic Christmas carol, those "eight maids a-milking" evoke an image of comfort and plenty (at least from a secular perspective). Being of Foolish mind, however, the lyric instead got me thinking about dairy costs -- specifically, how potentially higher milk and cheese prices could affect popular restaurant and food-service names.

At least one analyst sees 2010 dairy prices climbing as much as 20%. The forecast appears plausible: As the recession caused milk prices to curdle, farm closures and forced livestock sales reduced the number of U.S dairy cows, setting the stage for a supply-driven price move.

To keep you and your portfolio from suffering a sour stomach, I've highlighted eight companies that could see their profits squeezed, should a pricier pint-o-cow come to pass.

Lactose shock for the caffeine kings
OK, so your favorite coffee retailer is obviously affected by the going price of coffee beans -- but a lot of milk and cream also go into all those lattes and light-and-sweets.

Starbucks (Nasdaq: SBUX  ) grabbed attention in an early October Wall Street Journal article, in which David Palmer of UBS forecast that if milk simply held steady at then-current prices -- which had already started to move up from earlier in the year -- Starbucks would take a few-cents-per-share hit in 2010. And if milk prices actually head north, the impact to the $1 per share that analysts expect the company to earn could be substantial. (Starbucks responded to the article by noting its recent practices that hedge a portion of its milk costs.)

Through its 188 company-operated stores, the much smaller Peet's Coffee & Tea (Nasdaq: PEET  ) would also bellow with pain in a higher-cost environment. However, Peet's derives 66% of its sales from its branded stores, and nearly a third of that amount is in non-beverage sales. In short, the company's bottom line may be relatively well-insulated.

Where's the cheese?
That's what McDonald's (NYSE: MCD  ) customers were asking last year, when the burger giant flipped the double cheeseburger off the Dollar Menu, replacing it with the one-slice-thinner McDouble. In part, the price of cheese motivated the change, which also involved raising the classic double's price to $1.19.

In 2010, I'll keep an eye out for margin compression related to the company's slew of McCafe offerings. According to industry sources, the coffee beverages consist of as much as 80% milk. And although the majority of Golden Arches locations are franchised -- meaning that franchisees must shoulder higher costs -- McDonald's still derives the bulk of its sales from company-operated restaurants. Management is already competing with Starbucks and Dunkin Donuts in the coffee space, so offsetting potentially higher expenses with pricing adjustments might not be so easy.

Although it's a notch up from the quick-service ambiance of McDonald's, shareholders of casual-dining chain The Cheesecake Factory (Nasdaq: CAKE  ) should likewise beware dairy-market developments. Higher dairy prices have in part caused the company to miss Street estimates in the past, so it'd be no surprise to see a repeat performance in 2010. The company is unable to secure long-term contracts for most of its dairy items.

Lower profits by the slice
Rounding out our list of food-service names susceptible to margin trouble, we arrive finally at the pizza purveyors.

First off, I'll caution investors on Yum! Brands (NYSE: YUM  ) . Although management has been actively refranchising locations, the company still owns 23% of total stores and 14% of all Pizza Huts. As a company that posted a rise in recent quarterly profit thanks solely to lower costs, I'd hate to see what a spike in cheese costs could do to the bottom line.

California Pizza Kitchen and Papa John's (Nasdaq: PZZA  ) might run into trouble, too. The latter is already attempting to account for "some level of potential volatility in the average spot cheese price for the year." And management has disclosed that "a $0.25 per pound change in the restaurant cost of cheese" will likely translate into a $0.09-$0.10 move in earnings per share.

Instead, investors who can't do without their pizza fix might consider Domino's Pizza (NYSE: DPZ  ) . Although the company's not exactly lean on debt, it trades at a forward P/E of 8.4. More to the point, the company operates only a small fraction of its total stores, making it somewhat immune to point-of-sale margin pressure.

Foolish takeaway
Ultimately, a pricier block of cheddar or gallon of grade-A homogenized won't put any of these companies out of business. But when market researcher NPD Group doesn't see restaurant traffic turning positive until the second half of 2010, caution is in order. In the end, dairy costs could be the difference between companies meeting or missing investor expectations.

Follow along with our "12 Days of Christmas" article series:

Starbucks is a Motley Fool Stock Advisor selection. The Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Mike Pienciak doesn't own shares of any company mentioned in this article. The Fool has a rich, creamy, calcium-fortified disclosure policy.


Read/Post Comments (2) | Recommend This Article (5)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 18, 2009, at 1:51 PM, kristm wrote:

    Steak n' Shake. They have high exposure to dairy not only through cheese put on burgers but also through the ice cream and milk used in their shakes. Some fast food places that sell shakes have a limited risk because their shakes are powdered mix, but SnS uses real ice cream and real milk - I used to unload 600-800 gallons of ice cream A WEEK at one of the company's top franchises, and we used maybe 80-120 gallons of milk in the same time frame. Even a slight increase in dairy prices will put a big dent in the company's recent ill-advised stock increases. I have a red thumb on SNS in CAPS and own short shares in my real portfolio.

  • Report this Comment On December 18, 2009, at 2:14 PM, twofromyourhand wrote:

    Your remarks regarding MCD's sales are incorrect.

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