Food futures: Buy now, pay later

March 18, 2009 | by Valerie Killifer
Betting on food futures is as much a gamble as taking $200 to Las Vegas to play the slots. Sometimes you win, and sometimes you lose.
Last year, California Pizza Kitchen benefited from some well-placed wagers on where the price of cheese was headed. The company locked in prices on part of its cheese supply at the beginning of the year, a move which helped to insulate it as prices topped $2.20 per pound.
"The average price of cheese for us in 2008 ended up at around $1.88 per pound, said CPK's chief financial officer Susan Collyns during the company's 2008 year-end conference call with investors.
And Jim Fox, founder of the Fox's Pizza Den chain, ordered 20 truckloads of buns and pizza dough to store in the freezer at the company's headquarters as a hedge against rising flour prices.
It may be time for companies to place another bet.   While the costs of grains and dairy products have fallen in recent months, meat costs are increasing and dairy products are expected to follow suit.   According to the National Restaurant Association, wholesale food costs are expected to go up 2.9 percent in 2009. Although that number is significantly lower than the 8-percent hike food costs took in 2008, operators should continue to take a hard look at when, and for how long, they should play the market.
"Locking in, while not even at a great price, at least gives you a point of reference to know your downside exposure," said Craig Dunaway, president of Penn Station East Coast Subs. "If you lock in at a high price, at least you know what that price is."
Supply and demand
Who sets those costs is one factor operators need to consider when hedging their bets, as haggling over locked-in prices can last from six weeks to six months, given the differing mindsets at the table.
"I think it's smart to negotiate and not let the supplier dictate price," Dunaway said. "They're trying to maximize the cash they get, and as a chain, you're trying to minimize what you pay. I'd rather control my destiny than have a supplier/vendor control it."
For businesses that buy a year or more ahead, the risk naturally increases for operators and suppliers alike.   "The period of time creates the ‘risk' factor. The longer you go out, the more risk the supplier wants to factor in the price. The shorter the period, in theory, the less risk there is," Dunaway said. "I think you really, really need to understand (futures) to be successful, and with the volatility, you can lose your shirt."
Consider, for example, the Transit Authority of River City, which operates commuter bus service in Pizza Marketplace's hometown of Louisville, Ky.
When diesel fuel prices topped $4 per gallon last summer, TARC officials signed a one-year no-escape contract to purchase fuel at $3.92 per gallon. Now, although diesel is selling for $2.13 per gallon, the company is locked into paying the higher prices until August.  
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What's driving the increase?   In spite of some declining commodities costs, prices are still above historic norms from almost all food inputs that a restaurant uses, said Bill Lapp, principal of Omaha, Neb.-based Advanced Economic Solutions. 
A major catalyst for the increases has been the advent of a biofuels production mandate.
"We're absorbing a lot of the production of grains worldwide into energy channels rather than food channels," Lapp said. "While the economics are not favorable for the biofuels producers, mandated increases in their production will keep the pressure on in the coming years, unless those policies are reversed."
Lapp said restaurant operators will have to continue working with suppliers to moderate cost increases, and if they can't offset those costs by locking in prices, consumers will feel the effects.

Topics: Cheese , Financial Management , Pizza Sauce , Pizza Toppings

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