By Annie Gasparro
The nationwide drought is threatening restaurants with higher
food costs, but many chains say negotiating decent supply
contracts, cutting other costs and raising menu prices for
consumers will help protect their profits.
Dry, hot weather in the Midwest, which began in June, has
damaged crops of corn and soybeans, which are critical livestock
feeds that can drive up prices for beef and chicken. The drought
also has scorched grass in pastures and hurt the production of hay,
which cattle eat.
"We find the drought and corn [prices] to be at the forefront of
investor concerns and suspect the upcoming harvest could
meaningfully impact the industry," said Will Slabaugh, a restaurant
analyst at Arkansas-based investment bank Stephens Inc.
On Friday, the U.S. Department of Agriculture cut its forecast
for corn and soybean crops. "With poultry being the most direct
restaurant-level impact from rising corn prices, we clearly have
concerns around the trajectory of the crop's price," which has
risen almost 50% since the drought began, Mr. Slabaugh said.
McDonald's Corp. (MCD) Chief Financial Officer Pete Bensen said
his company's supply-chain folks "did a great job in securing a lot
of our grains and other commodities at costs before they ran up,
related to the recent drought."
He said the burger chain already has contracted a greater
percentage of its food costs for next year than usual. "So, we feel
pretty good that the impacts from the drought are going to be
minimized on next year's results," Mr. Bensen said on a recent
conference call.
But Wendy's doesn't lock in its beef costs with contracts as far
in advance, and its beef costs have been up about 10% recently.
Wendy's said the drought is causing temporary relief in beef
prices, as ranchers are sending cattle to market sooner, which
increases the supply. But it expects beef inflation to return to
double-digit levels next year, as higher feed costs ultimately
result in a thinner herd of cattle.
"We are currently seeing a short-term benefit in beef cost from
recent events," said Chief Financial Officer Steve Hare said
Thursday. "Unfortunately, when we look ahead to 2013...we still
think that fundamental, long-term supply-and-demand imbalance
that's out there for beef will kick back in."
Chicken suppliers also are breeding larger birds so they don't
have as many mouths to feed but can still meet contracts based on
weight.
Buffalo Wild Wings said its price of traditional chicken wings
has risen roughly 70% per pound from a year ago and that it is
receiving fewer wings per pound because the individual wings are
larger.
Buffalo Wild Wings raised some of its menu prices in July and
will implement another round of price increases next month. It also
is considering changing its menu next year to sell wings in
weight-based "single, double or triple" orders rather than specific
quantities of six, 12 and 18 pieces. "This allows for fluctuations
in case corn prices drop and they decide to sell smaller birds
again," Chief Executive Sally Smith said.
Restaurants have been struggling for more than a year with
rising food costs, as weak consumer confidence in the economy has
made it difficult for them to raise menu prices without deterring
traffic.
Scott Bergren, chief executive of Pizza Hut U.S., which is part
of Yum Brands Inc. (YUM), said it hasn't raised prices in 2 1/2
years and doesn't want to start now.
"We've had all kinds of disasters occur…it's always something.
This year, the corn crop is very weak in the Midwest, and wheat is
a little (weak)," Mr. Bergren said in an interview. "It provides a
few more hurdles we have to jump in order to not increase our
prices. But we're not intimidated by that. It's not as if we're not
affected; we're just outthinking the problems."
Extreme heat in Russia is leading to higher wheat prices too
since that crop also is damaged.
Einstein Noah Restaurant Group Inc.'s (BAGL) Chief Executive
Jeff O'Neill said on a recent conference call that given "what's
going on in Russia and the drought...it's so important that we've
had this disciplined focus on cost beyond commodities, right across
our business."
Many restaurant operators, such as Dunkin' Brands Inc. (DNKN),
license franchisees to run their stores and collect a flat-rate
royalty fee, which insulates them from the volatility of food
costs.
"Every quarter has got a commodity problem," Papa John's
International Inc. (PZZA) Founder and Chief Executive John
Schnatter said on a recent conference call. "It's just kind of
human nature to think you know you won't have a drought or channel
up on cheese, but there is always something going on that you got
to navigate around, and that's just the nature of the beast."
(Write to Annie Gasparro at annie.gasparro@dowjones.com)
Subscribe to WSJ: http://online.wsj.com?mod=djnwires