Why This Drought Won't Hurt Restaurants
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sir Isaac Newton’s third Law of Motion states that “when two bodies interact by exerting force on each other, these forces are equal in magnitude, but opposite in direction.” In layman’s terms, every action has an equal and opposite reaction. What most people do not consider is there are also secondary and tertiary reactions. It is on this premise that I will show you that the ongoing drought here in the U.S. will not impact the restaurant industry. At least, not in the short term.
When thinking about the initial effects of an ongoing drought, you would typically imagine higher feed costs for cattle and other livestock. The logical conclusion to this would be an immediate increase in the price one pays for, say, a steak or chicken breast. To support this conclusion, you might reference the conference calls of major companies in the restaurant industry such as Chipotle (NYSE: CMG), Buffalo Wild Wings (NASDAQ: BWLD), or Texas Roadhouse (NASDAQ: TXRH). Each of these companies mentioned that rising commodity costs are affecting their profitability. That being said, I don’t believe the cost of meat is the culprit.
In the last couple of months, farmers have been faced with a difficult choice: pay higher feed prices, or sell their livestock earlier than originally planned. The majority have chosen the slaughterhouse, driving down the average price of their wares due to higher supply. One basic rule of economics is that higher supply, when faced with steady demand, will cause prices to fall. Prices would then remain depressed until either supply dwindles, or demand increases.
Expanding on our last thought, let’s take a look at the secondary effects of high feed prices. While cattle farmers make their decision between higher costs and lower market prices, crop farmers have a question of their own to answer: Do they continue to sow the crops as originally planned, or do they switch to a higher proportion of the now higher-margin feed crops. Depending on the answer, one company in particular may be stuck between a rock and a hard place.
Panera Bread Co (NASDAQ: PNRA) is a restaurant chain which serves numerous food selections that include baked goods, sandwiches, and soups. Panera can be hit by this drought in two ways. First, if crop farmers decide to switch to the more profitable feed crops, the supply of various grains will fall. In the inverse of what we saw above, lower supply coupled with steady demand would cause prices to increase. The second potential impact would come later, after the oversupply of meat on the market is depleted. Since it takes time to raise the livestock required to meet demand, there may be a contraction in the supply, again, causing an increase in prices.
Tertiary effects take a little bit more time and effort to pin down. After taking the above into consideration, can you come to any conclusions that might point to a company which benefits from this drought? My choice, Berkshire Hathaway (NYSE: BRK-B), is obscure in that only part of the company would see increased operations. Burlington Northern Santa Fe, a railroad company that legendary value investor Warren Buffet purchased for Berkshire Hathaway in 2010, would see an increase in rail traffic in two instances. First, cattle farmers shipping more livestock than usual to the slaughterhouses would cause a bump in freight utilization. Second, a number of ranchers have decided to ship their cattle off to neighboring states to graze on cheaper feed, opting to use both trucks and rail for transportation. Either of the two mentioned scenarios would benefit the railways, including Burlington Northern.
The financial media has been fixated on higher commodity costs when discussing the current drought, but has failed to recognize the excess number of livestock being shipped to the slaughterhouses. In the short term, I believe the restaurants mentioned above will benefit from lower meat prices. In the medium term, I predict higher wheat prices as farmers switch to the more profitable feed crops. In the long term, the market will reach equilibrium and Newton’s third Law of Motion will once again be proved correct.
RoyalScribe owns shares of Berkshire Hathaway, Buffalo Wild Wings, Chipotle Mexican Grill, and Panera Bread. The Motley Fool owns shares of Berkshire Hathaway, Buffalo Wild Wings, Chipotle Mexican Grill, and Panera Bread. Motley Fool newsletter services recommend Berkshire Hathaway, Buffalo Wild Wings, Chipotle Mexican Grill, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.