Last week, Imperial Sugar (IPSU) lost 59% of its value in one day after reporting extremely poor earnings. The stock has continued to sell-off over a week later losing an additional 20%. The reason? IPSU is experiencing the worst of all operating squeezes: higher input costs (sugar) and the inability to raise prices to accommodate those costs. In this case, competitive pressures are to blame.
From the earnings report:
“Our inability to increase prices in the face of higher raw sugar costs because of competitive pressures from domestic and Mexican sources was the principal driver of the quarter’s disappointing results,” commented John Sheptor, president and CEO of Imperial Sugar. “Raw sugar purchased during the quarter was priced largely against the March and May futures contracts, which peaked near $40 per hundredweight prior to the USDA import quota announcement in early April. The subsequent decline in the raw sugar futures market which occurred after the quota announcement was only temporary and the raw market has rallied back to near the same level. Our raw sugar costs in the fourth fiscal quarter should see little relief, while sales prices thus far in the fourth quarter have only improved modestly.”
Higher manufacturing costs also hurt operating results in the previous quarter.
Hard disk manufacturer Seagate Technology reported earnings last night (July 20) and indicated that margins are getting hit by the rising prices of rare earths. Rare earth prices have risen particularly fast in the last 60 days. From the Seeking Alpha transcript of the earnings conference call:
“We do, however, expect a positive margin impact of a more stable pricing environment to be offset by the following factors: the costs of many upstream materials, especially rare earth elements, which have increased significantly. These costs are expected to adversely impact gross margins by at least 200 basis points…”
Seagate has been unable to offset these costs, but over the long-term believes there are no supply problems:
“In regards to the increasing cost of upstream materials, Seagate has historically been able to absorb these cost increases and insulate our customers. However, the recent dramatic increase in the cost of rare earth elements, combined with a pre-existing upward trend for a broad base of other commodities, far exceeds our ability to find offsetting cost reductions. While we are exploring opportunities to reduce the content of certain rare earth elements that are used in the manufacture of hard disk drive components, we will be discussing with our customers, passing through what we hope are temporary surcharges related to upstream earth-based commodities. It’s important to note that for the relevant rare earth materials, there does not appear to be a significant supply constraint. And while we have a short-term concern over margin impact, we do not currently have a long-term concern.”
During the Q&A session, Seagate management explained that rare earths are about 2% of the cost of a hard drive due to usage of rare earths in the the VCM magnet and the motor. Management also indicated there remains high uncertainty as to whether the company can pass on the higher costs of rare earths to customers although Seagate does not need to wait for demand of its drives to surpass supply in order to raise these prices.
Seagate appears very optimistic that no real supply issue exists with rare earths. Management is particularly optimistic that U.S. mines alone (presumable Molycorp?) will solve the problem and bring prices down. They even went so far as to call current prices a “bubble”:
“…it doesn’t appear that there’s a true supply constraint here. There’s a lot of dynamics around owners of rare earth materials and processors of rare earth materials and who is controlling inventories at what level, as opposed to there’s fundamentally some shortage. If there was fundamentally a shortage, then I would think that the fact that price is supposedly representing supply and demand. If you effectively reduce supply or enormously increase demand, that would mean that there’s a sustained increase in price. I think this feels a little bit like a bubble…So I think our point is that right now, since it doesn’t feel like there’s a fundamental supply issue, that it probably works itself out. And by the way, if these prices stay high, guess what, there’s a bunch of U.S.-based mines that are going to come online again, and it will solve itself. It’s not like the stuff doesn’t exist. It’s just that a lot of mines were closed down when the prices fell below $75, whatever the magic price is, and we’re well above that right now. So I don’t think it’s a long-term issue.”
Management compared the price run in rare earths to a run they experienced with ruthenium in 2006 that lasted for 2006. I do not know about the dynamics of that market. I will need to research more closely what happened in 2006 to understand the specific similarities to today’s rare earth market. Stay tuned…
Disclosure: Author is net long Molycorp (MCP)
Even fast food restaurants have determined that the market can accept some price hikes. In its latest earnings report, Wendy’s/Arby’s Group (WEN) provided an outlook that includes plans to implement “prudent” and “strategic” price increases to at least partially offset rising commodity prices, especially in beef (emphasis mine):
“We expect to generate strong sales growth at Wendy’s for the remainder of the year driven by exciting new product introductions, including hamburgers, chicken and salads, in addition to strategic price increases…Margins will be negatively impacted by increases in commodity costs primarily driven by unprecedented beef prices that are affecting the restaurant industry. We have reaffirmed our same-store sales outlook and expect to offset some of these commodity increases with prudent price increases, while protecting transactions and market share…”
WEN expects improved sales trends through the rest of the year, and this must help give them the confidence to raise prices.
The company’s confidence really shines through as management discusses future prospects further in light of higher commodity costs:
“Although we have revised our outlook for the year to reflect higher expected commodity costs, we continue to make significant strategic progress improving our core menu offerings including breakfast. We are also pleased with our progress developing Wendy’s international business, which represents a significant opportunity. The Arby’s turnaround is progressing nicely and we plan to resume our stock buyback program after the conclusion of the strategic alternatives process, subject to market conditions. As we’ve said before, 2011 is a transition year and we are confident that the investments we are making will position Wendy’s for 10% to 15% average annual EBITDA growth in 2012 and beyond…”
Disclosure: author owns WEN
Dean Foods (DF) is yet one more company demonstrating confidence in its ability to wield pricing power. DF reported earnings Tuesday that showed weak pricing in milk but a strong focus in raising prices to battle rising input costs (emphasis mine):
“…First, we have stepped up our agenda to reduce costs and improve profitability. Second, because input cost volatility is here to stay, we are focused on pricing to offset inflation through efficient pricing mechanisms. We are working hard to maintain, and where necessary, improve our pricing tools…”
I liked how the earnings announcement avoided direct mention of raising the prices of non-milk products.
The market liked the announcement too. The stock soared 11.5% on the day.
Peet’s Cofee (PEET) reported earnings results this evening. The company reaffirmed revenue targets for the year but lowered earnings guidance because of the rising cost of coffee (emphasis mine):
“Reaffirms full-year total net revenue growth in the 8% to 10% range. Lowers full-year diluted earnings per share guidance by $0.10 to the $1.43 to $1.50 range, driven entirely by the significant rise in coffee costs during the last three months“
Interestingly enough, PEET implied that the run-up in coffee prices is overdone. This news should provide some reassurance and relief to coffee fans, especially since it seems PEET is resisting the urge to ramp up its own prices to keep up with the rising input costs (emphasis mine):
“While we expect to offset most of the year-over-year coffee cost increase we’re experiencing, we will continue to act in the long-term best interests of our business and not overreact to the recent run-up in world coffee prices.”
Pilgrim’s Price (PPC) is the second-largest chicken producer in the world. It emerged from bankruptcy at the end of 2009 just as the economy was finally recovering from the recession. Over a year later, the company continues to struggle, especially with soaring costs for feed and energy.
PPC disappointed the market with its first quarter financial performance. The report contained some important information on market prices and industry cost pressures as well as the prospect for higher prices in the future. Key quotes below (emphasis mine):
“Market prices for breast meat averaged $1.26 per pound, down 10% from a year ago, while market prices for wings fell 38%, to $1.00 per pound.”
“Export demand remained very strong during the quarter, with volume rising 90% to an all-time record for the period and sales increasing by a similar amount. The company attributed export gains to the lower value of the dollar as well as chicken’s value proposition versus higher-priced beef and pork in international markets.”
“…the company has recently succeeded in negotiating additional price increases with some of its retail and foodservice customers in response to continued increases in feed costs.”
“Despite now having covered nearly all of our anticipated grain needs through the end of 2011, we are facing at least $500 million in higher feed costs this year. Our customers recognize that the unrelenting upward march of corn and soybean meal is placing extreme pressure on chicken producers and that there must be some sharing of the cost burden in order to ensure a viable business model. To achieve that, we will continue to look at further price increases and will execute structural changes in our book of business with regard to fixed versus market-based pricing…”
Note: PPC declined 9.5% in response to the first quarter’s earnings results.