Cheese prices cutting into pizza profits
By Jason Gale
Bloomberg News Service
Record cheese prices are eroding profits at Masamichi Hanasaki's Tokyo pizza bar, as the cost of mozzarella surged 58 percent the past two years.
"We'd like to raise our pizza prices, but we care about keeping our customers," said Hanasaki, who uses about 60 pounds of cheese a week at the Peco restaurant he manages in the Tokyo suburb of Daikanyama, where a 9.4-inch pizza topped with Swedish mozzarella, ham and zucchini costs $22. "I know of pizza restaurants that are closing because of cheese prices."
Global stockpiles are the lowest since 1971 as rising incomes increased demand in Russia and the Middle East and drought eroded milk output in Australia, which supplies 17 percent of cheese exports. Cheddar prices have risen 81 percent since November 2002, raising the estimated value of global cheese output to about $45 billion from $25 billion two years ago.
Higher prices crimped profit for cheese-users including Kraft Foods Inc., CEC Entertainment Inc.'s Chuck E. Cheese restaurants and Yum! Brands Inc.'s
Pizza Hut outlets. In Japan, the world's No. 2 cheese importer, higher prices are ratcheting costs at Snow Brand Milk Products Co. and Rokko Butter Co.
Cheese accounts for about 40 percent of the cost of a traditional pizza, according to Stephen Spence, a restaurant industry analyst with Longbow Research in Independence, Ohio.
The global price of mozzarella cheese rose to about $3,000 a ton this month compared with $1,900 two years ago, said Mi-
chael Harvey, a market analyst at Dairy Australia, a Melbourne-based trade and research group. A ton of cheddar fetches about $2,900, up from $1,600 in November 2002.
Consumption up
Cheese demand in the United States, the world's top consumer, rose 4.9 percent to about 4 million metric tons in 2002 from 2000, and is up 30 percent since 1993, government figures show. Cheese and beef are staples of high-protein diets such as Atkins and South Beach that increased in popularity the past few years.
Global production of cheese from cow milk, which is about 92 percent of total output, was 15.7 million tons last year, up 10 percent since 1998, the U.N. Food and Agriculture Organization said in May. Production dropped 1.4 percent from a record of 15.9 million tons in 2002.
Yum! Brands said last month that higher meat and cheese prices eroded profit margins at the Louisville, Ky.-based company's U.S. restaurants by 0.7 of a percentage point in the third quarter. At Irving, Texas-based CEC Entertainment, cheese added $3.2 million to food costs in the first half.
Domino's Pizza Inc., the largest pizza-delivery company in the United States, said last month that fiscal third-quarter profit was limited in part by higher cheese prices.
Historical peak
"The biggest problem with cheese prices was earlier this year, when they reached a historical peak," Domino's Chief Executive Officer David A. Brandon said in an Oct. 19 interview. "They're still up about 22 cents year against year, so we're still heading through a cheese market that's been stronger than what we would normally experience."
Every 10-cent increase in cheese prices erodes Domino's Pizza earnings by 1.5 cents a share, said Doug Sheres, a partner and portfolio manager for San Diego-based Rice Hall James LLC, which owns 1.55 million shares.
"Cheese has moderated as we expected, but we continue to see high prices in coffee, meats, energy and packaging," Kraft Chief Financial Officer James Dollive said during an Oct. 18 conference call.
Northfield, Ill.-based Kraft, the largest U.S. foodmaker and branded cheese seller, said Oct. 18 that third-quarter earnings fell 3.8 percent because of rising ingredient and marketing costs. The company cut its 2004 profit forecast for the second time in three months.
Eroding profits
Pretax profit this year at Kraft, which sold about $4.46 billion of cheese in the first nine months, will be eroded by $750 million because of higher costs for cheese, coffee, meat, energy and packaging compared with last year, the company said.
Louisville, Ky.-based Papa John's International Inc., the third-largest U.S. pizza chain with 2,809 restaurants, said in April that higher cheese costs would erode profit. Cheese represents about 35 percent to 40 percent of total costs.
Cheese, which averaged $1.30 a pound in January 2004, soared to $2.04 by March 29 before falling to $1.57 on average in September, according to Papa John's. Through Sept. 26, Papa John's spent $101 million buying cheese, up 8.9 percent from $92.6 million in 2003.
"Demand is pretty strong, particularly in Russia and the Middle East, where the economies are benefiting from higher oil prices," said Harvey of Dairy Australia.
Demand in Russia
In Russia, real incomes rose 13 percent in September from a year earlier after the world's largest oil producer benefited from record prices for crude. Increased spending by Russian consumers will spur an 8.6 percent rise in the nation's cheese imports this year after a 36 percent jump in 2003, the U.S. Department of Agriculture said this month.
A third of Russia's cheese imports come from Germany, where the department forecasts milk production will fall 1.1 percent this year and yet another 0.4 percent in 2005. Germany is the European Union's top dairy producer and biggest cheese maker.
"We aren't seeing any indicators that prices are going down," said Ian Langdon, chairman of Sydney-based Dairy Farmers, Australia's second-largest dairy company. "Milk production in Europe is still depressed and stock levels are low," Langdon, 60, said in an interview.
Declining inventories
Global cheese stockpiles are expected to fall to 603,000 tons by the end of the year, compared with 1.83 million tons in 1995, the USDA said on its Web site.
Rising spot prices for dairy products will translate into higher prices for food manufacturers and food service companies when they renew supply contracts, Langdon said.
That will help Warrnambool Cheese & Butter Factory Co., Bonlac Foods Ltd. and Australia's other dairy exporters to increase export revenue for the first time in three years.
"We've never seen this kind volatility before in the cheese market," said David Brown, who was director of commodity procurement for 12 years at Omaha, Nebraska-based ConAgra Foods Inc., the third-largest U.S. food company. "Small, incremental changes in production can cause big swings in price."
Dairy prices may rise
Japan's Rokko Butter Co., which buys 70 percent of its processed cheese from Australia and New Zealand, is anticipating an increase in dairy prices, which won't be passed onto customers, said spokesman Takanori Ishii.
"There's nothing we can do about it," he said.
Tokyo-based Snow Brand Milk Products Co. will try to buffer higher dairy costs by cutting its processing costs.
That's little comfort for Tokyo restaurateur Hanasaki, who has so far refused to skimp on cheese.
"It's not the customer's problem," he said. "We wish the Japanese government would do something."
