how will commodity affect restaurants

8/7/2019 How Will Commodity Affect Restaurants

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U.S. R ESTAURANTS : O RDERING FROM THE B ERNSTEIN V ALUE M ENU 57

Changing the Recipe How WillCommodity Moves Affect

Restaurants?We see limited risk of input cost spikes in the near term; we expect commodity

prices to increase, but at a moderate pace. We believe concerns about inflation persist, despite the more benign than expected trends reported thus far. Specifically,with emerging market economies recovering and U.S. consumption trendsremaining sluggish, the specter of 2008 when sales and cost trends went inopposite directions has risen. For our part, we think the evidence suggests thatsome of the concerns we are hearing over supply dynamics (particularly around

proteins) are overdone, and that changes in supply are well within historical norms.Moderate inflation is a positive for top-line trends; margins are likely to feel

some pressure but on net, profit dollars should benefit. We continue to view

moderate inflation (in the low single digits range) as the preferred scenario for restaurants, which lack the ability to take price in deflationary environments. Allthings equal, a 1% price increase leads to a less than 1% decline in traffic, meaningthat total revenue dollars are higher. Given fixed costs inherent in the business(labor and occupancy), resulting leverage largely offsets gross margin declines andtotal profit dollars are higher. From here, we expect pricing to trend up, withincreases in food-at-home raising the pricing umbrella for restaurants. While pricesgenerally lag cost increases, even absent 100% price pass through, the grossmargin-leverage trade-off is a good one for restaurants.

Menu mix and contract length dictate company risk; beef and dairy are likelythe wild cards, Burger King and Starbucks have the highest respective exposure,though Starbucks uses swaps/futures to hedge. Supply dynamics currently look fairly benign to us for dairy and milk, and companies are generally expecting priceincreases for both to be offset by price declines elsewhere. If, however, supply anddemand dynamics play out differently, the anticipated prices could climb higher than we expect. Among our coverage companies, Burger King has the highestexposure to beef (~19% of the food basket) and Starbucks has the highest exposureto dairy (~18% of the food basket). While Burger King does not hedge beef,Starbucks has initiated a program to mitigate the price uncertainty of a portion of dairy purchases.

We believe the commodity environment in 2010 will be generally favorable for restaurants, but we view McDonald's as best positioned to smooth volatility givenits global scale and international exposure. With its global scale and high degree of sophistication, we believe McDonald's is best positioned to mitigate commodityvolatility. Moreover, we view international exposure as a natural hedge againstrising commodity prices as part of the increase is likely to come from emergingmarkets and currency fluctuations. The ability to buy and sell goods in a localcurrency is critical then, to ensuring that costs and sales move together. The moreinternational businesses led by McDonald's are therefore likely to be best

positioned.

For the restaurant industry as a whole, food costs are in a virtual dead heat withlabor costs as the single most costly line item, account for nearly 40% of pretaxcosts equal to roughly one-third of sales (see Exhibit 103).

Overview

Restaurants Likely to See FoodCost Inflation by Year-End, ButWe Expect It to Be Moderate


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58 U.S. R ESTAURANTS : O RDERING FROM THE B ERNSTEIN V ALUE M ENU

Exhibit 103 Food Costs Account for One-Third of Total Expenses and Volatility Should Continueto Affect Profits

Food Services and Drinking Places Industry P&L

($ millions)Sales $437,798

Cost of Goods (E) 140,095 32%Labor 142,357 33%

Equipment 21,462 5%Services 23,704 5%Occupancy 34,018 8%Utilities 13,893 3%Interest, Sales Taxes, and Other 40,174 9%

Net Profit (E) $22,095 5%

Source: U.S. Bureau of the Census and Bernstein analysis.

For the better part of three decades, restaurants could count on declining foodcosts, which were then passed through to customers in the form of ever-increasing

portions and food-away-from-home (FAFH) inflation below the general pricelevels (see Exhibit 104).

But that benevolent trend reversed itself in the middle of this decade,

expanding into a full-blown bubble by 2008; the IMF's global commodity food and beverage index spiked 44% year-on-year that March. With the acceleratingrecession, however, prices dropped precipitously declining 26% in March 2009.

While much of the speculative excess has been squeezed out of agricultural prices by the global recession, prices remain at historically high levels. As theworld climbs out of the worst economic downturn since the global depression, a

broad index of commodity food and beverages still hovers nearly 40% above thelong-term average (see Exhibit 104). We believe the failure to return to early 2000slows suggest there is also some structural change, reflecting the economic recoverytaking place and emerging markets will continue to push food price growth aheadof the general inflation level.


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Exhibit 105 Historically, Beef Has Experienced Large Price Swings; the Spike in the Mid-2000sCorresponded to Elevated Restaurant Demand, But Prices Are Lower Now in RealTerms Than They Were 20 Years Ago

Inflation Adjusted Beef Prices

-40%-30%-20%-10%

0%10%20%

30%40%50%

1981 1982 1983 1985 1986 1987 1989 1990 1991 1993 1994 1995 1997 1998 1999 2001 2002 2003 2005 2006 2007 2009

Y e a r -

O v e r -

Y e a r C

h a n g e

0

50

100

150200

250

300

C e n

t s p e r

P o u n

d

Beef- cents per pound. (deflated) YoY Change Beef- cents per pound. (deflated)

Source: USDA, Bureau of Economic Analysis and Bernstein analysis.

In the United States during the current cycle, demand destruction brought on by the recession has driven primal beef prices down considerably (see Exhibit 106).

Prices for choice rib cuts and strip loins the types served by mid-price steak restaurants like Dardens Longhorn Steakhouse declined to multi-year lows in2009, according to CattleFax data. In contrast, prices for trimmings (the pieces of the cow used for ground beef) remained well above their historical average having set a record high price in 2009 as consumers traded down to cheaper cutsof meat in their own homes and in their choices in food away from home. Just asquick-service hamburger chains outperformed casual dining steakhouses, so too diddemand for the QSR mainstay, ground beef (see Exhibit 107).

Exhibit 106 Hamburger Meat Prices Were Bolstered byTrade Down, But Have Since Declined

Exhibit 107 Steak Cuts Have Climbed Off Their Multi- Year Lows

Weekly 81% Lean Beef & Beef Trimming Price

2007

2008

2009

2010

$0

$20

$40

$60

$80

$100

$120$140

$160

J an J an F eb M ar M ar A pr M ay J un J un J ul A ug A ug S ep O ct O ct N ov D ec D ec

P r i c e p e r 1

0 0 l b

2007 2008 2009 2010

Weekly Trimmed Tenderloin Prices

2007

2008

2009

2010

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

J an J an F eb M ar M ar A pr M ay M ay J un J ul J ul A ug S ep O ct O ct N ov D ec D ec

P r i c e p e r

1 0 0 l b

2007 2008 2009 2010

Source: USDA Market News Service and Bernstein analysis. Source: USDA Market News Service and Bernstein analysis.

With sputtering demand for most beef cuts weighing on retail prices, cattlefarmers' profitability has suffered (see Exhibit 108), and they have responded byreducing inventory (see Exhibit 109).


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Exhibit 108 Profitability Margins Have Narrowed for Cattle Producers Leading Them to ShrinkInventory

U.S. Beef Operating Margins

-17%-13%

-3%

6% 4% 4%

14% 17%

4%

-21%

-50%

-5% -8%

-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

O p e r a

t i n g

M a r g

i n s

Source: USDA and Bernstein analysis.

Yet, importantly, we note that this trend toward declining inventories has beenin place for decades. So, while herd levels are indeed at their lowest levels indecades, the same could have been said for 2004 and 2005, and before that, theentire 1980s decade.

Exhibit 109 The Downward Trend Has Been in Place for Decades, Implying Current Levels AreLess Dire Than They Initially Look

Cattle Inventory

8090

100110120130140150

1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 N u m

b e r o

f c o w s

( m m

h e a

d s )

Cattle & Calves - All Trai ling Average


Looking back over an even longer period, we find that inventory declines arenot particularly large by historical standards. As with many agriculturalcommodities, supply has become much less volatile over the ensuing decades sincethe hyper-inflation of the 1970s. As of January 2010, inventories were down just0.8% year-over-year (see Exhibit 110).


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Exhibit 110 Inventory Declines Have Not Been as Sustained as During the Recessions in the1970s and 1980s

Beef Inventory vs. Prices

-5%

0%

5%

10%

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Y / Y C h a n g e

i n

I n v e n t o r y

-20%-10%0%10%20%30%40%

Y / Y C h a n g e

i n P r i c e

Inventory Price

Source: USDA and Bernstein estimates and analysis.

After declining nearly 20% in August 2009, cattle futures indicate moderate price increases through most of 2010 (Exhibit 111). By the end of the year,however, as prices lap two years of declines, futures point to beef prices as much as14% higher year-over-year by December 2010.

Exhibit 111 Cattle Futures Imply Moderate Price Increases Accelerating Through 2010

YoY Changes in Commodity Prices

-60%-40%-20%

0%20%40%60%

J a n - 0

9 F e

b - 0 9 M a

r - 0 9 A p

r - 0 9

M a y - 0

9 J u

n - 0 9

J u l - 0

9

A u g - 0

9

S e p - 0

9 O c

t - 0 9

N o v - 0

9

D e c - 0

9 J a

n - 1 0 F e

b - 1 0 M a

r - 1 0 A p

r - 1 0

M a y - 1

0 J u

n - 1 0

J u l - 1

0

A u g - 1

0

S e p - 1

0 O c

t - 1 0

N o v - 1

0

D e c - 1

0 J a

n - 1 1 F e

b - 1 1 M a

r - 1 1

Y o

Y C h a n g e s

Beef Dairy

Source: Bloomberg L.P. and Bernstein analysis.

As with beef supply, dairy supply reflects decisions made as much as twoyears earlier, when demand and cost outlooks were very different from where theyare now. In the short term supply is virtually inelastic, such that even small demandshifts lead to large swings in prices. The steep declines in exports and domesticdemand led to sharp price declines the January 2009 Class III milk price, at$9.45 per hundredweight, was at a five-and-a-half-year low but milk prices havesince clawed their way back. By January, price had climbed back above $14,though it remains below the peak of $20 that we saw in 2007 and 2008 (see Exhibit112).


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Exhibit 112 Smaller Herds and Improving Demand Point to Firmer Prices Ahead

Dairy Prices

$0.5$1.0

$1.5

$2.0

$2.5

Jan-05

Apr-05

Jul-05

Oct-05

Jan-06

Apr-06

Jul-06

Oct-06

Jan-07

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

D o

l l a r s p e r

P o u n

d

Nonfat Dry Milk Cheddar 40lb Butter


In response to plummeting prices, dairy farmers rapidly thinned their herds. Of note, dairy cow beef tends to be directed to the ground beef market, further augmenting supply and lowering prices in the current environment, but pointing toa reversal ahead.

While prices were quite favorable for 2009, they have already strengthened

from 2009 lows, and we expect this to continue through 2010. For the restaurantoperators, who buy on a three- to six-month lag, we expect favorable year-over-year compares through the first part of 2010 followed by steady increases (seeExhibit 113).

Exhibit 113 Futures Prices Imply Significant Increases in Late 2010 Followed by a Steadier Rise

YoY Changes in Fluid Milk Prices

-60%

-40%-20%

0%20%40%60%

J a n - 0

8

M a r - 0 8

M a y - 0 8

J u l - 0 8

S e p - 0

8

N o v - 0

8

J a n - 0

9

M a r - 0 9

M a y - 0 9

J u l - 0 9

S e p - 0

9

N o v - 0

9

J a n - 1

0

M a r - 1 0

M a y - 1 0

J u l - 1 0

S e p - 1

0

N o v - 1

0

J a n - 1

1

M a r - 1 1

M a y - 1 1

J u l - 1 1

S e p - 1

1

N o v - 1

1

Y o

Y C h a n g e s

Fluid Milk

Source: Bloomberg L.P. and Bernstein research.

Despite vastly shorter lead times chicken farmers can respond far more quicklyto changes in production profitability chicken prices have also proved volatile.In 1Q:09, falling demand started to take a toll on prices; year-over-year pricechanges slipped from +9% in January to -2% in March and fell further through theyear. Looking over a longer term, however, we find that chicken prices have beenessentially flat in real terms (see Exhibit 114).

Chicken Prices Look to BeFavorable Through the Year,Though Lower InventoriesPresent Some Upside Risk inOur View


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Exhibit 114 In Real Terms, Chicken Prices Are Virtually Unchanged Since the 1980s, But PriceChanges Have Varied Widely

Inflation Adjusted Chicken Prices

-20%

-10%

0%

10%

20%

30%

1981 1982 1983 1985 1986 1987 1989 1990 1991 1993 1994 1995 1997 1998 1999 2001 2002 2003 2005 2006 2007 2009

Y e a r -

O v e r -

Y e a r

C h a n g e

0102030405060708090

C e n

t s p e r

P o u n

d

Poultry (chicken)- cents per pound (deflated) YoY Change Poultry (chicken)- cents per pound (deflated)

Source: USDA, Bureau of Economic Analysis and Bernstein analysis.

On the supply side, chicken production declined sharply (year-over-year) beginning at the end of 2008 and continuing through most of 2009 (see Exhibit 115and Exhibit 116). These sharply reduced production levels suggest that even atcurrent lower demand levels, prices could firm up more quickly than in the prior cycle. On December 1, 2008, Pilgrim's Pride, the largest U.S. chicken producer,filed for bankruptcy, removing a significant amount of supply capacity from themarket.

Exhibit 115 Chick Placement Declined in 2008 and Mostof 2009

Exhibit 116 Leading to Sharply Lower ChickenProduction

19-City Chick Placements

140,000

145,000

150,000

155,000

160,000

165,000

170,000

175,000

180,000

185,000

J an J an F eb M ar A pr A pr M ay J un J un J ul A ug A ug S ep O ct O ct N ov D e c D ec

Millions of Birds

2007 2008 2009 2010

Chicken Production

2,500,000

2,750,000

3,000,000

3,250,000

3,500,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

C e r

t i f i e d P o u n d s

( 0 0 0 )

2007 2008 2009 2010

Source: USDA and Bernstein analysis. Source: USDA and Bernstein analysis.

Shorter lead times allow for less volatility in production and price versus beef,giving companies greater visibility into chicken costs (see Exhibit 117). For thisreason, contracts tend to be more widely available than for beef. As a result, weexpect chicken costs to remain favorable for restaurants in the near term. Brinker has already announced that its chicken prices have reset lower.


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Exhibit 117 However, Prices Remain Low and Inventories Are Back at Year-Ago-LevelsSuggesting Sufficient Supply

Chicken Inventory vs. Price

-15%-10%

-5%

0%5%

10%15%

J a n - 9

2 J a

n - 9 3

J a n - 9

4 J a

n - 9 5

J a n - 9

6 J a

n - 9 7

J a n - 9

8 J a

n - 9 9

J a n - 0

0 J a

n - 0 1

J a n - 0

2 J a

n - 0 3

J a n - 0

4 J a

n - 0 5

J a n - 0

6 J a

n - 0 7

J a n - 0

8 J a

n - 0 9

J a n - 1

0

Y / Y C h a n g e

i n

I n v e n

t o r y

-50%-30%-10%

10%30%50%

Y / Y C h a n g e

i n P r i c e

Inventory Change Price Change


Despite falling throughout 2009, poultry prices are expected to continueremaining favorable through the year, with prices expected to fall materially in late2010 (see Exhibit 118).

Exhibit 118 Futures Imply Favorable Chicken Trends from Here


-40%-30%-20%-10%

0%10%20%30%40%

J a n - 0

9

F e b - 0

9

M a r - 0 9

A p r - 0 9

M a y - 0 9

J u n - 0

9

J u l - 0 9

A u g - 0

9

S e p - 0

9

O c t - 0 9

N o v - 0

9

D e c - 0

9

J a n - 1

0

F e b - 1

0

M a r - 1 0

A p r - 1 0

M a y - 1 0

J u n - 1

0

J u l - 1 0

A u g - 1

0

S e p - 1

0

O c t - 1 0

N o v - 1

0

D e c - 1

0

J a n - 1

1

F e b - 1

1

M a r - 1 1

Y o Y

C h a n g e s

Poultry


As with agricultural commodities, demand destruction has placed downward pressure on seafood prices (see Exhibit 119). Lobster, a highly discretionary luxury,is perhaps the clearest example. Cruise ships and casinos the primary buyers for much of the world's processed, frozen lobster have pulled back sharply on their orders as visitor traffic has fallen. Prices fell precipitously in the fall of 2008 andremained low in 2009; in Florida, fishing boats that sold lobster at $7 a pound just afew years ago were as recently as November getting only $3 per pound. Retail

prices in the region are also down to $6-$7 a pound, 35% lower than a year ago.Going forward, we expect the reverse to be true, as firming demand drives priceshigher.

Seafood Prices Are GenerallyTied to Demand Swings; WeSee Little Risk of Higher PricesAbsent Stronger Demand


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Exhibit 119 Demand Destruction Weighed Heavily on Lobster Prices

Maine Lobster Prices and Landings

0

20

40

60

80

2000 2001 2002 2003 2004 2005 2006 2007 2008

M i l l i o n s o f

P o u n d s

$0.00

$1.00$2.00

$3.00

$4.00

$5.00

P r i c e p e r

P o u n d

Millions of Pounds Price per Pound

Source: Department of Marine Resources and Bernstein analysis.

Despite a boom in demand from growing affluence in emerging economies andincreased health awareness in industrialized nations, fish prices have declined inreal terms. Improvement in farming techniques have contributed to a nearly 80%decline in the real price of shrimp over the past 30 years (see Exhibit 120). But over shorter periods of time e.g., the late 1980s, early 2000s prices can go higher;as such, we are likely to see prices rise again in the near term.

Exhibit 120 In Real Terms, Shrimp Prices Have Grown Less Volatile as Aquaculture HasImproved Supply Visibility; Prices Remain Down Year-on-Year But Should Rise WithDemand

Year-on-Year Change in Real Shrimp Prices

-32%-50%-25%

0%25%50%75%

100%

F e b - 8

2

A u g - 8

2

F e b - 8

3

A u g - 8

3

F e b - 8

4

A u g - 8

4

F e b - 8

5

A u g - 8

5

F e b - 8

6

A u g - 8

6

F e b - 8

7

A u g - 8

7

F e b - 8

8

A u g - 8

8

F e b - 8

9

A u g - 8

9

F e b - 9

0

A u g - 9

0

F e b - 9

1

A u g - 9

1

F e b - 9

2

A u g - 9

2

F e b - 9

3

A u g - 9

3

F e b - 9

4

A u g - 9

4

F e b - 9

5

A u g - 9

5

F e b - 9

6

A u g - 9

6

F e b - 9

7

A u g - 9

7

F e b - 9

8

A u g - 9

8

F e b - 9

9

A u g - 9

9

F e b - 0

0

A u g - 0

0

F e b - 0

1

A u g - 0

1

F e b - 0

2

A u g - 0

2

F e b - 0

3

A u g - 0

3

F e b - 0

4

A u g - 0

4

F e b - 0

5

A u g - 0

5

F e b - 0

6

A u g - 0

6

F e b - 0

7

A u g - 0

7

F e b - 0

8

A u g - 0

8

F e b - 0

9

A u g - 0

9

F e b - 1

0

Year-on-Year Change Real Global Aggregate, Shrimp, Frozen Shell-On Head

Source: IMF and Bernstein analysis.

Wheat prices' near doubling between 2006 and 2008 also hit restaurant P&Ls.Wholesale flour prices peaked in the three months ended February 2008, growing158% over the prior year. But correction was swift and severe; by mid-2009 flour

prices had fallen back nearly to 2006 levels and remain 20% below year-ago levels(see Exhibit 121, Exhibit 122 and Exhibit 123).

We Expect Wheat PriceIncreases to Return in 2H, ButLow Price-to-Volume RatiosLimit the Impact of Grain PriceFluctuations.


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Exhibit 121 Wheat Prices Increased 250% Between2006 and 2008 Before Correcting Sharply(But Not Fully)

Exhibit 122 Flour Prices Remain Sharply Lower

Global Aggregate Wheat Price

-60%

-40%-20%

0%

20%

40%

60%

80%

100%120%

140%

J a n - 9

9

J u n - 9

9

N o v - 9 9

A p r - 0 0

S e p - 0

0

F e b - 0

1

J u l - 0 1

D e c - 0 1

M a y - 0 2

O c t - 0

2

M a r - 0 3

A u g - 0

3

J a n - 0

4

J u n - 0

4

N o v - 0 4

A p r - 0 5

S e p - 0

5

F e b - 0

6

J u l - 0 6

D e c - 0 6

M a y - 0 7

O c t - 0

7

M a r - 0 8

A u g - 0

8

J a n - 0

9

J u n - 0

9

N o v - 0 9

Y e a r - O v e r -

Y e a r

C h a n g e

$0

$50$100

$150

$200

$250

$300

$350

$400$450

$500

P r i c e

( $ / M T )

Global Aggregate, Wheat, No.1 Hard Red Winter Y/Y Growth Global Aggregate, Wheat, No.1 Hard Red Winter

Wholesale Flour Price

0

5

10

15

20

25

30

1Q99 4Q99 3Q00 2Q01 1Q02 4Q02 3Q03 2Q04 1Q05 4Q05 3Q06 2Q07 1Q08 4Q08

D o l

l a r s p e r

C W T

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

Y / Y C h a n g e

%

Wholesale price of bakery flour Y/Y change in bakery flour

Source: International Monetary Fund, Global Insight and Bernsteinanalysis. Source: USDA Wheat Yearbook and Bernstein analysis.

Exhibit 123 Wheat Futures Imply Modest Spot Market Inflation in 1H, But More Material Increasesin 2H


-60%

-40%

-20%

0%

20%

J a n - 0

9

F e b - 0

9

M a r - 0 9

A p r - 0 9

M a y - 0

9

J u n - 0

9

J u l - 0 9

A u g - 0

9

S e p - 0

9

O c t - 0

9

N o v - 0 9

D e c - 0 9

J a n - 1

0

F e b - 1

0

M a r - 1 0

A p r - 1 0

M a y - 1

0

J u n - 1

0

J u l - 1 0

A u g - 1

0

S e p - 1

0

O c t - 1

0

N o v - 1 0

D e c - 1 0

J a n - 1

1

F e b - 1

1

M a r - 1 1

Y o Y

C h a n g e s

Wheat


For Starbucks, coffee is the single most important input. As with other commodities, in 2009, coffee futures were pummeled by the combination of declining demand and a stronger dollar (see Exhibit 124). But recovery camesomewhat quicker than for other commodities, bolstered by production declinesfrom cyclically slower planting period, draught conditions, and reduced investments

by farmers in fertilizer and pruning (see Exhibit 125).

Coffee Is the LargestCommodity Input for Starbucks; While Futures Pointto Higher Prices Ahead,Starbucks PurchasesSelectively and for Longer Term


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Exhibit 124 Like Other Commodities, Coffee PricesDeclined Through Most of 2009 But HaveSince Started Rising Again

Exhibit 125 And the Longer Term History IsCharacterized by Two- to Three-Year Cycles, Suggesting Prices Will ContinueTrending Up from Here

Coffee Prices

-60%

-40%

-20%

0%

20%40%

60%

80%

J a n - 0

6

M a r - 0 6

M a y - 0 6

J u l - 0 6

S e p - 0

6

N o v - 0

6

J a n - 0

7

M a r - 0 7

M a y - 0 7

J u l - 0 7

S e p - 0

7

N o v - 0

7

J a n - 0

8

M a r - 0 8

M a y - 0 8

J u l - 0 8

S e p - 0

8

N o v - 0

8

J a n - 0

9

M a r - 0 9

M a y - 0 9

J u l - 0 9

S e p - 0

9

N o v - 0

9

J a n - 1

0

Y e a r -

O v e r -

Y e a r C h a n g e

Y/Y Growth Global Aggregate, Coffee, Other Mild ArabicasY/Y Growth Global Aggregate, Coffee, Robusta, International

Coffee Prices

-100%

-50%

0%

50%

100%

150%

200%

250%

1981 1982 1984 1985 1987 1988 1990 1992 1993 1995 1996 1998 2000 2001 2003 2004 2006 2007 2009

Y e a r -

O v e r -

Y e a r

C h a n g e

Y/Y Growth Global Aggregate, Coffee, Other Mild ArabicasY/Y Growth Global Aggregate, Coffee, Robusta, International

Source: IMF and Bernstein analysis. Source: IMF and Bernstein analysis.

As a result, futures price project a steady increase in coffee prices ahead,though we note that Starbucks buys selectively from growers with which is haslonger-term relationships, improving its visibility and limiting its exposure to rising

prices this year (see Exhibit 126).

Exhibit 126 Futures Prices Imply Rises in Coffee Prices, But Starbucks Buys Selectively andWith Longer Contracts


-60%

-40%

-20%

0%

20%

J a n - 0

9

F e b - 0

9

M a r - 0 9

A p r - 0 9

M a y - 0

9

J u n - 0

9

J u l - 0 9

A u g - 0

9

S e p - 0

9

O c t - 0 9

N o v - 0

9

D e c - 0

9

J a n - 1

0

F e b - 1

0

M a r - 1 0

A p r - 1 0

M a y - 1

0

J u n - 1

0

J u l - 1 0

A u g - 1

0

S e p - 1

0

O c t - 1 0

N o v - 1

0

D e c - 1

0

J a n - 1

1

F e b - 1

1

M a r - 1 1

Y o Y

C h a n g e s

Coffee


Of course over the long term, prices have repeatedly converged on a downwardsloping trend reflecting the agricultural industry's ability to consistently extract

productivity gains (see Exhibit 127 and Exhibit 128). In the U.S alone, between1950 and 2000, annual per cow milk production more than tripled, from 5,314

pounds to 18,201 pounds, while over the same time period, corn yields rose from39 bushels to 153 bushels per acre. Even farmers grew more productive, producing12 times as much farm output per hour worked as in 1950.


13/29


14/29


Exhibit 129 Food-Away-from-Home Prices Are Stickier Than Food-at-Home Prices; FoodserviceOperators Absorb More of the Gains and Losses from Changing Commodity Prices

CPI Food-at-Home vs. Food-Away-from-Home

0%1%2%3%

4%5%6%

J a n - 0

4

A p r - 0 4

J u l - 0 4

O c t - 0

4

J a n - 0

5

A p r - 0 5

J u l - 0 5

O c t - 0

5

J a n - 0

6

A p r - 0 6

J u l - 0 6

O c t - 0

6

J a n - 0

7

A p r - 0 7

J u l - 0 7

O c t - 0

7

J a n - 0

8

A p r - 0 8

J u l - 0 8

O c t - 0

8

J a n - 0

9

A p r - 0 9

J u l - 0 9

O c t - 0

9

J a n - 1

0 C P I A w a y - f r o m -

H o m e

Y / Y

C h a n g e

-4%-2%0%2%4%

6%8%10%

C P I A t - H

o m e

Y / Y

C h a n g e

CPI Food-Away-From-Home CPI - Food-at-Home

Source: Bureau of Labor Statistics and Bernstein analysis.

The corrollary is that pricing and top-line growth are more moderate evenwhen commodity prices spike. The spread between commodity cost and end pricetends to widen when prices are falling and narrow when prices are rising (seeExhibit 130 and Exhibit 131).

Exhibit 130 Restaurants Tend to Raise Prices Steadily, Rather Than in Response to CommodityPrice Swings, Creating Gross Margin Swings

Food-Away-from-Home CPI vs. Crude Foodstuffs PPI

-30%

-20%-10%

0%10%

20%

30%

40%

1981 1982 1983 1985 1986 1987 1989 1990 1991 1993 1994 1995 1997 1998 1999 2001 2002 2003 2005 2006 2007 2009

P P I

Y O Y C h a n g e

PPI Crude Foodstuffs CPI Food-Away-from-Home



15/29


Exhibit 131 There Is Generally a 1-2 Quarter Lag Between Shifts in Spot Markets and Changes inMenu Prices

Changes in Price Indices

2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012EPalm Oil 17% -1% -4% 30% 53% -3% -23% 5% 6% 5%Wheat 10% -2% 6% 18% 47% 15% -20% -13% 1% 2%

Milk 3% 29% -6% -15% 48% -5% -29% 10% 12% 3%Cheese 8% 41% 15% -11% 57% 17% -50% -5% 11% 5%Beef 26% 0% 3% -2% 8% 0% -3% 6% 4% 2%Chicken 12% 20% -4% -9% 19% 4% 1% 0% 2% 1%

Average 13% 14% 1% 2% 38% 5% -21% 1% 6% 3%

PPI - Fin. Cons. Foods -4% 8% 6% 5% 10% 10% -11% -10% 3% 5%CPI - FAFH 2.2% 2.7% 3.2% 3.1% 3.4% 4.2% 4.5% 1.5% 3.0% 3.0%

Note: Grains and oilseeds data are calculated using the average of consecutive marketing years (ending May).

Source: Food and Agricultural Policy Research Institute, Bureau of Labor Statistics and Bernstein analysis.

In light of this expectation for volatile inputs, we think margins are likely toswing more widely in the near term. As commodity prices have declined in the pastsix months, the gap between growth in input costs and growth in end prices hasgone from significantly positive implying margin pressure to sharplynegative implying margin support (see Exhibit 132). From here, we expect year-over-year benefits through 1H:10 to turn to headwinds in 2H:10.

Exhibit 132 The Prices Restaurants Set Are Far More Stable Than the Input Costs They Pay,Helping Margins in 2009 and Early 2010, But Adding Pressure in 2H10

Food-Away-from-Home CPI vs. Crude Foodstuffs PPI

0%

1%

2%3%

4%

5%

6%

F e b - 0

4

M a y -

A u g - 0

4

N o v - 0

4

F e b - 0

5

M a y -

A u g - 0

5

N o v - 0

5

F e b - 0

6

M a y -

A u g - 0

6

N o v - 0

6

F e b - 0

7

M a y -

A u g - 0

7

N o v - 0

7

F e b - 0

8

M a y -

A u g - 0

8

N o v - 0

8

F e b - 0

9

M a y -

A u g - 0

9

N o v - 0

9

F e b - 1

0

C P I Y O Y C h a n g e

-0.3-0.2-0.100.10.20.30.4

P P I Y O Y C h a n g e

CPI Food-Away-from-Home PPI Crude Foodstuffs

Note: Crude foodstuffs are defined as "basic agricultural products that will undergo some processing prior to becoming completed food products, as well agricultural products consumed directly by the agricultural sector. Examples include fresh fruit that will be canned or raw corn consumed by livestock as animal feed. Other examples would be cattle, hogs, or chickens intended for slaughter, or raw canesugar that will be refined."


On net, though, the pressure on the top-line comps has generally offset the benefit of lower commodities as fixed costs deleverage on the lower sales.

While price pass-through is not 100%, an analysis of what the industry lookslike under different inflation scenarios is illustrative. At this pass-through rate, weestimate that the difference between 2% of inflation and 2% of deflation is upwardsof 80 bp of net margin (see Exhibit 133).


16/29


17/29


Exhibit 135 Beef Is the Largest Commodity for the Hamburger Restaurants But Is a Major Contributor for All But Starbucks

BKC YUM DRI EAT SBUX JACKBeef 19% 15% 14% 15% 20%Cheese 5% 15% 5%Chicken 11% 18% 6% 15% 11%Coffee 36%

Dairy 6% 5% 11% 10% 18% 6%Cocoa 3%Other 28% 20% 18% 43% 42% 40%Pork 5% 5% 5% 5%Potatoes 8% 3% 8%Produce 5% 7% 13% 10% 5%Seafood 30% 2%Soft Drinks 13%Wheat 12% 8%Total 100% 100% 100% 100% 100% 100%

Note: Estimates in bold, JACK is not covered by Bernstein.

Source: Corporate reports and Bernstein estimates and analysis.

Exhibit 136 Companies Generally Expect Commodity Benefits to Continue for Several Quarters,Though the Length Depends on the Nature of ContractingCommodities Chicken Beef Dairy

BKC Company restaurant marginspressured by food cost inflation

Weighted avg. food Index decreased5% YoY, largely driven by 21% declinein beef costs YoY. Beef represents19% of COGS

DRI75% of food commodity costs for theremainder of the FY have been lockedin at favorable rates

EATMinor sequential disinflation t hroughFY:10. 80% of commodities under contract thru 06/10, 70% thru 12/10

Significant favorability for CY10(annual price resets; new contract for aportion of supply)

MCD

U.S. : Grocery bill (commodity costs)fell 4% in Q, Europe : Local currencygrocery bill (commodity costs) fell 3%in Q

SBUXSignificant improvement in U.S. COGSdriven by lower food costs andelimination of dairy waste

Commodities expect the balance of the year to be flat YoY, withunfavorable dairy costs offset byfavorable coffee costs

WEN

Rest. margins up 100 bp YoY due tolower commodity costs. Commoditytailwinds in 4Q net both brandsshould see 6% to 8% commodity costreduction. Modest commodityincreases expected in 2010

YUM

YRI expect commodity deflation in4Q as contracts renewed. FY:10limited visibility, will depend on two bigswing factors (cheese and beef)

China margins returned to 2007levels (after initial chicken commoditycost inflation in 3Q:07)

Benefited from very low cheese costso far this year (especially in 2Q and3Q). See that ticking up a bit in 4Q

Source: Corporate reports and Bernstein analysis.

McDonald's does not disclose details of its commodity basket, but beef accounts for 15% of the basket, and chicken and dairy are next in importance (see Exhibit 137).There was no proxy for future produce or "other" prices, so they were left out of our estimated indices. By lagging each component by 0-6 months, to adjust for thehedging contracts, we created a regression that correlates well the estimatedcommodity index against McDonald's' reported food & paper expense growth, withan R-square of 47% (see Exhibit 138).

McDonald's


18/29


19/29


Exhibit 140 McDonald's Sensitivity: Change in Food & Paper Expense; a 10% Increase in BothBeef and Dairy Prices Would Increase McDonald's's Food & Paper Costs by 3.0%

Beef -20% -10% 0% 10% 20%

-40% -9.0% -7.5% -6.0% -4.5% -3.0%-30% -7.5% -6.0% -4.5% -3.0% -1.5%-20% -6.0% -4.5% -3.0% -1.5% 0.0%

-10% -4.5% -3.0% -1.5% 0.0% 1.5%0% -3.0% -1.5% 0.0% 1.5% 3.0%

10% -1.5% 0.0% 1.5% 3.0% 4.5%20% 0.0% 1.5% 3.0% 4.5% 6.0%30% 1.5% 3.0% 4.5% 6.0% 7.5%40% 3.0% 4.5% 6.0% 7.5% 9.0%

D a

i r y

Source: Bloomberg L.P., corporate reports and Bernstein estimates and analysis.

With its narrower menu, Burger King's commodity basket is somewhat moreindexed to beef than McDonald's is. Beef, chicken, and dairy are more than three-quarters of its total food cost (see Exhibit 141). By lagging each component bythree to nine months, to adjust for the hedging contracts, we created a regressionthat correlates well against Burger King's reported U.S. food, paper, and productexpense growth, with an R-square of 85% (see Exhibit 142).

Exhibit 141 Burger King's Estimated Commodity IndexConsists of Mostly Beef, Chicken, andDairy, and We Adjust for Hedging byLagging Commodity Prices by 3-9 Months

Exhibit 142 Burger King's Estimated Commodity IndexCorrelates Well With Burger King'sReported US Food, Paper, & ProductExpense Growth (R-Square: 85%)

Burger King Commodity Basket

InputEstimated/

Reported %Index

WeightTime Lag(Months)

Beef 19% 32% 3Chicken 11% 19% 3Pork 4% 7% 6Dairy/Oil 15% 25% 9Pasta/Bread 10% 17% 9Produce 10% n/aOther 31% n/aTotal 100% 100%

Burger Kingy = 1.002x + 0.0382

R2 = 0.8457

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

-20% -10% 0% 10% 20% 30%

YoY Change in Commodity Cost (Lagged)

Y o

Y C h a n g e

i n R e p o r t e

d F o o

d , P

a p e r ,

& P r o

d u c

t E x p e n s e

Note: Estimates in bold.

Source: Bloomberg L.P., corporate reports and Bernstein estimatesand analysis.


Based on futures prices for the main components in our estimate of Burger King's commodity basket, we forecast that Burger King U.S. food, paper and

product expense growth should decline in the single digits in the first half of theyear, but the benefit will be offset by the increases in the latter half of the year (seeExhibit 143). Similar to McDonald's, the sharp declines in chicken prices will

Burger King


20/29


likely be modestly offset by the higher dairy prices, and Burger King's largeexposure to beef's price inflation may bring its food costs up. Our sensitivityanalysis indicates a 5.8% increase in food costs if beef and dairy prices were toeach rise 10% (see Exhibit 144).

Exhibit 143 Our Burger King Commodity Model Projects US Food, Paper and Product ExpenseGrowth Will Accelerate from Negative-Single Digits to High-Single Digits in 2010

Burger King US: Food, Paper and Product Costs

-20%-10%

0%10%20%30%

3 Q : 0 6

4 Q : 0 6

1 Q : 0 7

2 Q : 0 7

3 Q : 0 7

4 Q : 0 7

1 Q : 0 8

2 Q : 0 8

3 Q : 0 8

4 Q : 0 8

1 Q : 0 9

2 Q : 0 9

3 Q : 0 9

4 Q : 0 9

1 Q : 1 0

E

2 Q : 1 0

E

3 Q : 1 0

E

4 Q : 1 0

E

1 Q : 1 1

E

2 Q : 1 1

E

3 Q : 1 1

E

4 Q : 1 1

E

Calendar Quarter Reported Y/Y Change Projected Y/Y Change


Exhibit 144 Burger King Sensitivity: Change in U.S. Food, Paper and Product Costs; a 10%Increase in Both Beef and Dairy Prices Would Increase Burger King's U.S. Food &Paper Costs by 5.8%

Beef -20% -10% 0% 10% 20%

-40% -16.6% -13.4% -10.2% -6.9% -3.7%-30% -14.1% -10.8% -7.6% -4.4% -1.2%-20% -11.5% -8.3% -5.1% -1.9% 1.4%-10% -9.0% -5.8% -2.5% 0.7% 3.9%

0% -6.4% -3.2% 0.0% 3.2% 6.4%10% -3.9% -0.7% 2.5% 5.8% 9.0%20% -1.4% 1.9% 5.1% 8.3% 11.5%30% 1.2% 4.4% 7.6% 10.8% 14.1%

40% 3.7% 6.9% 10.2% 13.4% 16.6%

D a

i r y


Our estimated commodity basket for Wendy's is in line with that of other fast foodhamburger restaurants. The majority of Wendy's's costs should come from beef,chicken, and dairy (Exhibit 145).

Wendy's/Arby's


21/29


Exhibit 145 Wendy's Estimated Commodity Index Consists of Mostly Beef, Chicken and Dairy,and We Adjust for Hedging by Lagging Commodity Prices by Six to Nine Months

Wendy's Arby's Commodity Basket

InputEstimated/

Reported %Index


Beef 20% 31% 9Chicken 15% 23% 6Pork 5% 8% 9Dairy/Oil 15% 23% 6Pasta/Bread 10% 15% 9Produce 10% naOther 25% naTotal 100% 100%



Wendy's decision to report aggregated restaurant expenses confounds anyregression of cost changes against margins; changes in margins reflect not onlycommodity swings but also changes in occupancy and labor costs as well as salesleverage/deleverage. As a result, we cannot reliably estimate an equation. Wetherefore rely on a sensitivity analysis to provide a range of possible outcomesunder various scenarios for beef and dairy prices (see Exhibit 146).

Exhibit 146 Wendy's Sensitivity: Change in Cost of Sales; a 10% Increase in Both Beef and DairyPrices Would Increase Wendy's Cost of Sales by 3.5%

Beef -20% -10% 0% 10% 20%

-40% -10.0% -8.0% -6.0% -4.0% -2.0%-30% -8.5% -6.5% -4.5% -2.5% -0.5%-20% -7.0% -5.0% -3.0% -1.0% 1.0%-10% -5.5% -3.5% -1.5% 0.5% 2.5%

0% -4.0% -2.0% 0.0% 2.0% 4.0%

10% -2.5% -0.5% 1.5% 3.5% 5.5%20% -1.0% 1.0% 3.0% 5.0% 7.0%30% 0.5% 2.5% 4.5% 6.5% 8.5%40% 2.0% 4.0% 6.0% 8.0% 10.0%

D a i r y


Yum!'s commodity basket is skewed more towards chicken than the other QSRsdue to KFC (see Exhibit 147). Besides poultry, dairy and beef also are largecomponents of Yum!'s food costs. After lagging each cost by 0-12 months, wecreated a regression that correlates our estimated commodity index very well withYum!'s food and paper expense, with an R-square of 65% (see Exhibit 148).

Yum! Brands


22/29


Exhibit 147 Yum!'s Estimated Commodity IndexConsists of Mostly Beef, Chicken andDairy, and We Adjust for Hedging byLagging Commodity Prices by 0-12 Months

Exhibit 148 Yum!'s Estimated Commodity IndexCorrelates Well With Yum!'s Reported Food& Paper Expense Growth (R-Square: 65%)

Yum! Brands Commodity Basket

InputEstimated/

Reported %Index


Beef 15% 22% 6Chicken 18% 26% 0Pork 5% 7% 12Dairy/Oil 18% 26% 3Pasta/Bread 12% 18% 6Produce 15% naOther 17% naTotal 100% 100%

YUMy = 0.5714x - 0.072

R2 = 0.6512

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

-40% -20% 0% 20% 40%

Y/Y Change in Commodity Cost (Lagged)

Y / Y C h a n g e

i n R e p o r t e

d F o o

d & P a p e r

E x p e n s e


Source Bloomberg L.P., corporate reports and Bernstein estimates andanalysis.


Commodity futures prices indicate that Yum!'s food and paper expense shouldfall in the low single digits in 2010. After what we estimate to be a ~15% decline inthe first quarter, the benefits of lower commodity costs should lessen throughoutthe year, averaging to a 7-8% decline in 2010, according to our regression (seeExhibit 149). According to our sensitivity analysis, Yum!'s food and paper costswould increase 3.3% with 10% higher beef and dairy costs (see Exhibit 150).

Exhibit 149 Our Yum! Commodity Model Projects Food & Paper Expense Will Decline in the LowSingle Digits in 2010

Yum!: Food and Paper Expense

-25%-20%-15%-10%

-5%0%5%

10%15%

1Q:04 3Q:04 1Q:05 3Q:05 1Q:06 3Q:06 1Q:07 3Q:07 1Q:08 3Q:08 1Q:09 3Q:09 1Q:10E 3Q:10E 1Q:11E

Reported Y/Y Change Projected Y/Y Change



23/29


24/29


increase in both beef and dairy prices could mean a 2.5% increase in food and beverage expense (Exhibit 154).

Exhibit 153 Our Darden Commodity Model Projects Food & Beverage Expense Growth inthe Mid-Single Digits in 2010

Darden: Food and Beverage Expense

-20%-10%

0%10%20%30%40%

1 Q : 0 4

2 Q : 0 4

3 Q : 0 4

4 Q : 0 4

1 Q : 0 5

2 Q : 0 5

3 Q : 0 5

4 Q : 0 5

1 Q : 0 6

2 Q : 0 6

3 Q : 0 6

4 Q : 0 6

1 Q : 0 7

2 Q : 0 7

3 Q : 0 7

4 Q : 0 7

1 Q : 0 8

2 Q : 0 8

3 Q : 0 8

4 Q : 0 8

1 Q : 0 9

2 Q : 0 9

3 Q : 0 9

4 Q : 0 9

1 Q : 1 0

E

2 Q : 1 0

E

3 Q : 1 0

E

4 Q : 1 0

E

1 Q : 1 1

E

2 Q : 1 1

E



Exhibit 154 Darden Sensitivity: Change in Food & Beverage Costs; a 10% Increase in Both Beef and Dairy Prices Would Increase Darden's Food & Beverage Costs by 2.5%

Beef -20% -10% 0% 10% 20%

-40% -7.2% -5.8% -4.4% -3.0% -1.6%-30% -6.1% -4.7% -3.3% -1.9% -0.5%-20% -5.0% -3.6% -2.2% -0.8% 0.6%-10% -3.9% -2.5% -1.1% 0.3% 1.7%

0% -2.8% -1.4% 0.0% 1.4% 2.8%10% -1.7% -0.3% 1.1% 2.5% 3.9%20% -0.6% 0.8% 2.2% 3.6% 5.0%30% 0.5% 1.9% 3.3% 4.7% 6.1%40% 1.6% 3.0% 4.4% 5.8% 7.2%

D a i r y


Without the seafood component that Darden has with the Red Lobster concept,Brinker's commodity basket looks a lot more like that of a hamburger QSR. Themajority of costs come from proteins like beef and chicken, followed by dairy and

bread products. The best regression was created by lagging only dairy by threemonths, while the other commodities fit with either no lag or a six-month lag (seeExhibit 155). Brinker's food costs were the most difficult to predict with an R-square of 0.34 when regressed against Brinker's actual cost of sales growth (seeExhibit 156).

Brinker International


25/29


Exhibit 155 Brinker's Estimated Commodity IndexConsists of Mostly Beef and Chicken, andWe Adjust for Hedging by LaggingCommodity Prices by 0-6 Months

Exhibit 156 Brinker's Estimated Commodity IndexCorrelates Well With Brinker's ReportedCOGS Growth (R-square: 34%)

Brinker Commodity Basket

InputEstimated/

Reported %Index


Seafood (Shrimp, Lobster, Crab) 2% 4% 0Beef 15% 26% 6Chicken 15% 26% 6Pork 5% 9% 0Dairy/Oil 10% 18% 3Pasta/Bread 10% 18% 0Produce 10% naOther 33% naTotal 100% 100%

Brinker y = 1.0339x - 0.0149R2 = 0.339

-30%

-20%

-10%

0%

10%

20%

30%

-20% -10% 0% 10% 20%


Y / Y C h a n g e

i n R e p o r

t e d C o s

t o f S a l e s




Based on our regression, futures prices point to low-single-digit growth inBrinker COGS, averaging to about flat for calendar 2010 (though we note thatBrinker has implied some benefits from reset contracts) see Exhibit 157. For thefollowing year, our regression would imply a 1-2% decline in 2011. A 10%increase in both beef and dairy prices would create a 2.5% growth in Brinker'sCOGS, according to our sensitivity analysis (see Exhibit 158).

Exhibit 157 Our Brinker Commodity Model Projects Cost of Sales Growth in the Low SingleDigits in 2010

Brinker: Cost of Sales

-30%-20%-10%

0%10%20%30%

1 Q : 0 4

2 Q : 0 4

3 Q : 0 4

4 Q : 0 4

1 Q : 0 5

2 Q : 0 5

3 Q : 0 5

4 Q : 0 5

1 Q : 0 6

2 Q : 0 6

3 Q : 0 6

4 Q : 0 6

1 Q : 0 7

2 Q : 0 7

3 Q : 0 7

4 Q : 0 7

1 Q : 0 8

2 Q : 0 8

3 Q : 0 8

4 Q : 0 8

1 Q : 0 9

2 Q : 0 9 3 Q

: 9 4 Q

: 0 9

1 Q : 1 0

E

2 Q : 1 0

E

3 Q : 1 0

E

4 Q : 1 0

E

1 Q : 1 1

E

2 Q : 1 1

E

3 Q : 1 1

E

4 Q : 1 1

E




26/29


Exhibit 158 Brinker Sensitivity: Change in Cost of Sales; a 10% Increase in Both Beef and DairyPrices Would Increase Brinker's Food & Paper Costs by 2.5%

Beef -20% -10% 0% 10% 20%

-40% -7.0% -5.5% -4.0% -2.5% -1.0%-30% -6.0% -4.5% -3.0% -1.5% 0.0%-20% -5.0% -3.5% -2.0% -0.5% 1.0%

-10% -4.0% -2.5% -1.0% 0.5% 2.0%0% -3.0% -1.5% 0.0% 1.5% 3.0%

10% -2.0% -0.5% 1.0% 2.5% 4.0%20% -1.0% 0.5% 2.0% 3.5% 5.0%30% 0.0% 1.5% 3.0% 4.5% 6.0%40% 1.0% 2.5% 4.0% 5.5% 7.0%

D a

i r y

Source: Bloomb Bloomberg L.P., corporate reports and Bernstein estimates and analysis.

Unlike the other restaurants, Starbucks' commodity basket is dominated by coffee,which accounts for 15% of Starbucks cost of sales and dairy, which is 8% (seExhibit 159). In our best-fit regression, each of those commodities is lagged bythree months. The resulting commodity index is well-correlated with StarbucksCOGS, which also includes occupancy (we assume occupancy remains the same inour projection). With an R-square of 0.52, dairy and coffee costs are a fairly good

predictor of future COGS growth (see Exhibit 160).

Exhibit 159 Starbucks's Estimated Commodity IndexConsists of Mostly Coffee and Dairy, andWe Adjust for Hedging by LaggingCommodity Prices by Three Months

Exhibit 160 Starbucks's Estimated Commodity IndexCorrelates Well With Starbucks's ReportedCOGS Growth (R-Square: 53%)

Starbucks Cost of Goods Sold

InputEstimated/

Reported %Index


Dairy 10% 33% 3Coffee 19% 67% 3

Food 23% naFreight/Distribution 14% naOther 34% naTotal 100% 100%

Starbucksy = 1.4939x + 0.0799

R2 = 0.5228

-20%

-10%

0%

10%

20%

30%

40%

-10% -5% 0% 5% 10% 15%


Y / Y C h a n g e

i n R e p o r

t e d C o s

t o f S a l e s


Source Bloomberg L.P., corporate reports and Bernstein estimates andanalysis.


Because of the large increases in dairy prices in 2010, our regression indicatesa dramatic food-cost inflation for Starbucks averaging 15% for calendar 2010(see Exhibit 161). Our estimates, however, are more muted, as Starbucks' cost of

Starbucks Coffee Co.


27/29


sales includes occupancy, which should be down year-over-year due to morefavorable real estate pricing. Additionally, Starbucks has hedging contracts in placefor both coffee and dairy, which should lessen the impact of rising commoditycosts. Starbucks COGS are modestly sensitive to changes in coffee and dairy

prices; a 10% increase in dairy and coffee prices would raise COGS by 2.9% (seeExhibit 162).

Exhibit 161 Our Starbucks Commodity Model Projects COGS Growth (Including Occupancy) in

the Mid-Teens in 2010

Starbucks: Cost of Sales Including Occupancy

-20%

0%

20%

40%

1 Q : 0 4

3 Q : 0 4

1 Q : 0 5

3 Q : 0 5

1 Q : 0 6

3 Q : 0 6

1 Q : 0 7

3 Q : 0 7

1 Q : 0 8

3 Q : 0 8

1 Q : 0 9

3 Q : 0 9

1 Q : 1 0

E

3 Q : 1 0

E

1 Q : 1 1

E

3 Q : 1 1

E

1 Q : 1 2

E



Exhibit 162 Starbucks Sensitivity: Change in Cost of Sales Including Occupancy; a 10% Increasein Both Coffee and Dairy Prices Would Increase Starbucks's COGS by 2.9%

Coffee-20% -10% 0% 10% 20%

-40% -7.7% -5.8% -3.9% -1.9% 0.0%-30% -6.8% -4.8% -2.9% -1.0% 1.0%-20% -5.8% -3.9% -1.9% 0.0% 1.9%-10% -4.8% -2.9% -1.0% 1.0% 2.9%

0% -3.9% -1.9% 0.0% 1.9% 3.9%10% -2.9% -1.0% 1.0% 2.9% 4.8%20% -1.9% 0.0% 1.9% 3.9% 5.8%

30% -1.0% 1.0% 2.9% 4.8% 6.8%40% 0.0% 1.9% 3.9% 5.8% 7.7%

D a

i r y


The most recent commodity run-up served as a reminder that exchange ratesinfluence the demand for farm exports (which are traded in dollars) andconsequently global farm commodity prices. The U.S. dollar declined steadily from2002 through mid-2008, the same period during which commodity prices followeda steady upward trajectory. The recent sharp pullback in commodity pricescoincided with a rapid dollar appreciation (see Exhibit 163 and Exhibit 164).

Here we see a parallel with the 1970s (one of many), when rising commodity prices reflected increased demand for U.S. farm exports, triggered by the decliningU.S. dollar. As the dollar appreciated in the subsequent decade, commodity pricescame crashing back down.

Going forward, if the dollar weakens, globally traded goods (including foodcommodities) will become more expensive to American consumers.


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Exhibit 163 Lower Nominal Commodity Prices PartlyReflect a Stronger Dollar

Exhibit 164 Real Global Demand for U.S. AgriculturalProducts Moves Opposite USD Prices

U.S. Agricultural-Trade Weighted Exchange Rates

40

50

60

70

80

90

100

110

120

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Monthly Commodity Trade Weighted Exchange Rates: U.S. Markets Agricultural Trade

Real Agricultural Trade

$1

$2

$3

$4

$5

$6

1975 1977 1979 1981 1982 1984 1986 1988 1989 1991 1993 1995 1996 1998 2000 2002 2003 2005 2007 2008

B i l l i o n s

Real Exports Real Imports

Source: USDA Economic Research Service and Bernstein analysis. Source: USDA Economic Research Service and Bernstein analysis.

As a result, we think that international exposure offers a natural offset to dollar weakness.

Exhibit 165 For Burger King and Yum!, Margins Moved in Opposite Directions for U.S. and Non-U.S. Regions, Reflecting the Impact of Dollar Strength/Weakness

Restaurant Margins by Company and Sector

YUM BKCU.S. 2008 2009 2008 2009Sales $4,410.0 $3,738.0 $1,271.0 $1,315.8

Food and Beverage $1,335.0 30.3% $1,070.0 28.6% $423.7 33.3% $426.0 32.4%Restaurant Labor 1,329 30.1% 1,121 30.0% 390 30.7% 412 31.3%Restaurant Expenses 1,195 27.1% 1,028 27.5% 298 23.4% 298 22.7%

Total Cost of Sales $3,859.0 87.5% $3,219.0 86.1% $1,111.6 87.5% $1,136.5 86.4%Restaurant Margin 12.5% 13.9% 12.5% 13.6%

InternationalSales $2,375.0 $2,053.0 $536.0 $483.7

Food and Beverage $752.0 31.7% $656.0 32.0% $152.6 28.5% $142.0 29.4%Restaurant Labor 618 26.0% 533 26.0% 169 31.6% 159 32.9%

Restaurant Expenses 742 31.2% 635 30.9% 145 27.0% 136 28.2%Total Cost of Sales $2,112.0 88.9% $1,824.0 88.8% $466.9 87.1% $437.2 90.4%Restaurant Margin 11.1% 11.2% 12.9% 9.6%

Source: Corporate reports and Bernstein analysis.

see Exhibit 166 McDonald's Has the Most International Exposure in Our Coverage2008 Global Revenue Mix by Region 2008 EBIT Mix by Region

MCD YUM BKC SBUX EAT WEN MCD YUM BKC SBUX EAT WENAPMEA 18% 41% 3% 18% 0% 2% APMEA 12% 48% 3% 1% 1% 1%Europe 42% 18% 24% 8% 0% 0% Europe 38% 8% 15% 0% 0% 0%

L. America 1% 1% 4% 1% 0% 1% L. America 2% 2% 8% 0% 0% 1%

N. America 39% 41% 69% 74% 100% 97% N. America 48% 41% 74% 99% 99% 99%

Source: Bureau of Labor Statistics, corporate reports and Bernstein analysis.


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how will commodity affect restaurants

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