This summer's weekend barbecue just got more expensive. Beef prices are up 8% compared to prices last year. For example, the April 2014 price for sirloin steak was $7.36 per pound, compared to $6.80 per pound in April last year. Not to be outdone, shrimp prices are also skyrocketing. The cost of domestic shrimp two years ago was $5 per pound. As of the first quarter of 2014, that shrimp cost has doubled.
What do higher beef and shrimp costs mean to restaurant companies such as the Ruth's Chris and Mitchell's Fish Market restaurants of Ruth's Hospitality Group (RUTH); the Del Frisco's Double Eagle, Del Frisco's Grille, and Sullivan's restaurants of Del Frisco's Restaurant Group (DFRG); and the Outback, Fleming's, and Bonefish restaurants of Bloomin' Brands (BLMN -0.85%)? How will they handle the rising costs of beef and shrimp? What Foolish insight can you get into how each of them manages their costs?
Why is the cost of beef "moo"-ving up?
The typical reasons given for higher beef prices -- the drought in the Western United States and the outbreak of e. coli -- haven't had as much of an impact as one would think. The drought will eventually impact beef prices, but beef futures have allowed companies to secure pricing in the near term. And while the May 2014 e. coli scare prompted officials to remove nearly 2 million pounds of meat, this has not made a dent in demand. In fact, it is the growing consumer demand that has driven beef prices up this year.
Corralling beef prices
All three of the companies have taken active measures to lock in beef prices in the near term, but concede that they may eventually pass growing beef costs onto the customer.
On the company's April earnings call, Ruth's Hospitality CFO Arne Haak stated that the company's beef costs rose 4% in the first quarter. Haak added that, for the balance of the year, beef costs are expected to rise between 5%-8%. Haak noted that Ruth's Hospitality was able to enter into a pricing agreement to lock in 25% of its May-to-December beef needs at prices 3%-4% above last year's prices. The CFO conceded that trying to lock in beef pricing would be challenging in the future.
On the company's April earnings call, Del Frisco's CFO Thomas Pennison stated that the company had been able to hedge against the rising beef costs, although there was still some pressure in the first quarter as its costs rose by 5%. However, by adding different types of foods in the menu mix, beef costs as a percentage of total cost of sales went down from 33.5% in the first quarter of 2013 to 33.2% in the first quarter of 2014. Pennison was cautious about the year-end expectation of a 5%-8% increase -- his guess was that it would even be higher, in the 7%-9% range. He admitted there may be a time when the company's restaurants will pass rising beef costs to the consumer, having already done so in late 2013.
While Del Frisco's first quarter 2014 cost of sales increased $1.7 million, or 8.8%, to $20.1 million from $18.4 million in the first quarter of 2013, as a percentage of consolidated revenues, its cost of sales decreased to 30.1% from 30.8%. This is due to finding ways, such as expanding the lunch mix, that increase Del Frisco's revenues for the quarter with lower food costs.
On the company's May earnings call, Bloomin' Brands CFO David Deno covered the rising commodity costs, especially for beef. Deno projected a 2%-4% inflation in the costs for the year. Deno elaborated that Bloomin' Brands was able to lock in commodity costs for 84% of its beef needs for the year. He praised Bloomin' Brands' supply chain team for its ability to cover much of the beef costs at a relatively manageable increase.
Why are there jumbo prices for shrimp?
Shrimp prices have skyrocketed due to the two basic economic forces: supply and demand. The shrimp supply has been hit hard due to disease that is wiping out shrimp in producing countries such as Thailand, India, and Vietnam. Demand has also grown as China has increased its consumption of shrimp, often outbidding the United States.
The shrimp producers are facing decreasing output due to a disease called "acute hepatopancreatic necrosis syndrome," commonly known as early mortality syndrome, or EMS. EMS often means 100% mortality within days once it appears in the aquaculture. While there are tests for early EMS detection, there is no treatment available at this time.
Once a shrimp producer, China is now importing shrimp to meet its demand. China's own shrimp production has fallen by 22% in 2013 compared to 2012, a reduction of 200,000 tons of shrimp. As a result, China imported 30.3% more shrimp in 2013 compared to a year ago to meet its demand, but this also drove costs up for other shrimp importers.
Are they avoiding the shelling?
Unlike with beef costs, the three restaurant companies had differing levels of concern when it came to shrimp costs.
In the April earnings call, Haak said that Ruth's Hospitality's biggest commodity price pressure was shrimp costs. While noting that other commodity costs were manageable, he predicted a 30% year-over-year increase in shrimp costs. The increasing pressure of both seafood and beef drove up the food and beverage costs as a percentage of restaurant sales to 31.6% in the first quarter of 2014, compared to 31.2% during the same period last year.
While Del Frisco's does not have a seafood-branded restaurant, shrimp costs are still a concern for it. On the April earnings call, Pennison pointed out the pricing pressure for seafood components, shrimp in particular. He added that while declines in other component commodity prices were able to offset the rises in seafood and beef, overall commodity prices for Del Frisco's will still go up 5%-8% for the remainder of the year.
While Del Frisco's first quarter 2014 cost of sales (food and beverage costs) increased $1.7 million, or 8.8%, to $20.1 million from $18.4 million in the first quarter of 2013, as a percentage of consolidated revenues, its cost of sales decreased to 30.1% from 30.8%. This is due to finding ways, such as expanding the lunch mix, that increase Del Frisco's revenues for the quarter with lower food costs.
On the May earnings call, Bloomin' Brands CFO was confident that the company had secured its shrimp pricing, in terms of overall commodity costs. Deno commented, "[W]e are locked up about 65% in shrimp and the reason why we're not locked up more is because... there probably [are] some opportunistic buys that we have going forward. But overall we are extremely pleased with where we stand on the commodity front."
For Bloomin' Brands, the cost of sales grew to 32.5% in the first quarter 2014 compared to 32.3% from the same period last year. Bloomin' Brands broke out its increases due to:
- 0.5% from higher beef and other commodity costs,
- 0.5% from higher seafood costs,
- 0.4% increase related to new and promotional menu rollouts and
- 0.3% from changes in our product mix.
Which one is worth the turf? Which one do you let surf?
All three of the restaurant companies have taken steps to mitigate the impact of rising beef costs, at least for the remainder of the year. However, the exploding shrimp costs give all three greater concerns. These companies' management of the increase in shrimp costs offers insight into the effectiveness of their supply chain operations and how they leverage their hedging opportunities.
Of the three, I'd be most wary of Ruth's Hospitality. It has a branded seafood restaurant, which accounts for 20% of the mix of company owned restaurants. Its CFO has already acknowledged that shrimp costs will increase by nearly a third. Ruth's Hospitality has better control of its beef costs, but the increasing shrimp and seafood costs be more of a factor in its growing food and beverage costs.
With no uniquely branded seafood restaurant, Del Frisco's has less exposure than Ruth's Hospitality. Del Frisco's believes that its commodity costs -- taken as a whole -- are rising at a manageable rate.
Bloomin' Brands is the strongest of the three in managing its commodity costs, even with a branded seafood restaurant. It has been able to rein in a majority of both its beef and shrimp costs for the year, and is aggressively looking for future opportunities to lock in future prices.
While all three have their eye on the beef, sometimes it's how you treat the shrimp that is the most telling. In this instance, Bloomin' Brands is the clear winner in the battle of the shrimp.
