Say Goodbye To The Ethanol Mandate; Time To Gorge On Restaurant Stocks
As I’ve written several times here, I believe a dramatic collapse in food prices is already underway and will continue over the next several years benefitting restaurants and the consumer, generally. The bubble in food prices was caused by the EPA’s “corn ethanol mandate” but now that the mandate has been revised, corn, wheat, hay, and cotton prices have plummeted and pork prices are down 60% in just a few months. Soon beef and poultry prices will also collapse. Meanwhile, bipartisan opposition to the mandate grows. There are now four separate bills on Capital Hill calling for an end to the mandate.
Most investors and observers think that when a piece of legislation or regulation becomes law, it’s permanent. Sometimes that’s true but often, it’s not – especially regarding ambitious legislation that rearranges large swaths of the economy.
Legislative initiatives and regulations only last as long as their political support lasts. And political support wanes when economics necessitates it. That’s exactly what’s happened with the Renewable Fuel Standard’s corn ethanol mandate.
While many observers discount the EPA’s recent cut to the ethanol mandate, we think it’s profound when taken in context with history. Several years ago, it seemed the original terms of the mandate were permanent.
But the economic and political pressure rightly increased until the EPA removed the subsidies and tax credits in December of 2012, only after the drought that year had unleashed its fury on corn prices. Up 400% in just a few years, the pressure to reform the corn ethanol mandate grew unbearable and the EPA begrudgingly announced a cut in September of 2013. Recently that cut has become permanent. Meanwhile, opposition to the mandate is growing across the political spectrum, from Washington to the environmental left.
So, the cut to the ethanol mandate should be looked at two ways – first, how it affects demand for corn right now, second, what it means for the future of the legislation long term. Taken in the latter context, we think it’s a sign that the ethanol mandate is ultimately doomed.
Ethanol mandate will consume 31 billion FEWER pounds of corn per year:
EPA Proposes Renewable Fuel Standards for 2014, 2015, and 2016 – Almost 2 years after EPA head Gina McCarthy first proposed cuts to the ethanol mandate, the EPA finally announced the rules. The new proposal calls for a cut to the ethanol mandate by more than 1.5 billion barrels per year in 2014-2016. It doesn’t address later years which means it might be left to another administrator after the election. On the margin, that’s negative for the mandate.
More importantly, four bipartisan proposals call for an end to the corn ethanol mandate:
“The Corn Ethanol Mandate Elimination Act of 2015” – In January, Diane Feinstein announced legislation that would immediately remove all ethanol volume requirements from the RFS. Not exactly a right winger, it’s significant that the San Francisco Democrat is being so aggressive.
“The Renewable Fuel Standard Reform Act of 2015” – Proposed by two Democrats and two Republicans, this legislation would remove the corn ethanol mandate in the RFS and prohibit the EPA from approving gasoline with greater than 10 percent ethanol.
“The American Energy Renaissance Act of 2015”— Introduced in Congress on 4/3/15 by Republicans Sen. Ted Cruz and Rep. Jim Bridenstine, the bill plans to phase out the ethanol mandate by 2020 alongside other much bolder energy proposals. While this bill gives a glimpse into the Republican playbook on energy policy if they were to win the Presidency, it is not expected to pass.
“The Renewable Fuel Standard Repeal Act of 2015”— recently proposed by Republican Sen.Bill Cassidy of Louisiana, this piece of legislation would completely repeal the Renewable Fuel Standard by taking it out of the Clean Air Act.
Regardless of the success of these initiatives, it is clear that the political pressure is increasing to end the ethanol requirements found in the RFS. Amazingly, the environmental press is now criticizing the ethanol mandate. Though we believe the political pressure will continue under a Clinton presidency, a Republican president would all but assure the demise of the Renewable Fuel Standard.
The great inflation in the agriculture sector is over. At the very least, corn, wheat, hay and soybeans prices will not return to prior highs as long as the ethanol mandate is under pressure. But if the mandate didn’t exist, I would expect corn prices to trade at their long term average price of about $2.00 per bushel – half of where they are now. As for protein prices – poultry, pork and beef – they will fall by 50% over the next several years (see my previous Forbes poston this topic). This will be a boon to consumers and a boon to restaurants that are heavily centered on proteins.
Expect higher cattle inventories when the USDA releases their “all cattle and calves report” on July 24th
Cattle futures have been weak recently and I expect them to weaken further as we approach the next USDA cattle inventory report. I expect a bigger increase in inventories than we saw in the last report. Reports of rainfall in cattle country might help take the pressure off prices, too. Once the price correction becomes apparent, investors will start looking for beneficiaries. That process may have already started as even the weakest restaurant operators are rallying strongly today. In fact, it’s the broken charts that are showing the most upside (and that makes sense).
Here are just a few of the beneficiaries in the restaurant space:
1. Bloomin Brands (BLMN) – with restaurant chains such as Fleming’s and Outback Steakhouse, Bloomin is very dependent on beef and other proteins. Coupled with the benefit they will receive as protein prices fall, Bloomin has strong leadership making it a safe choice.
2. Buffalo Wild Wings BWLD -1.38% (BWLD) – 25% of their cost of sales comes from chicken. A large decrease in the cost of chicken could lead to a huge increase in their operating margin to go with their current rapid growth. On April 28th, management announced that a 41% increase in chicken prices was weighing down the business. Incidentally, the company is projecting a drop in wing prices which will accelerate the company’s earning’s growth.
3. Chipotle (CMG) – A perennial grower with a high multiple, Chipotle has cited the rising price of beef as a headwind. What I don’t like about the management is their political correctness. They took pork off of the menu due to a supplier’s inhumane cultivation practices. Many vegans would argue that raising any animals for slaughter and human consumption is inhumane.
4. Fogo de Chao (FOGO) – Like El Pollo Loco, FOGO is a busted IPO. The company reports that 57% of their food and beverage costs are from beef. Imagine if that cost fell by 50%. The quiet period from the IPO ends on 7.14.15.
5. McDonalds (MCD) – McDonald MCD +1.71% is the safest choice of the bunch due to its consistent high dividend payments. McDonalds sells over 1 billion pounds of beef per year. If the price of beef collapses they could see their costs reduced substantially and this would have a subsequent positive effect on their stock price.
Nelson Jetmundsen assisted on this article.
Source: Forbes.com
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