Wednesday, August 10, 2016

Ethanol, Cattle, and Steak

Thomas Landstreet is bearish on cattle and bullish on steak.  The reason:  government ethanol mandates are under political pressure.  In 2007, the head of the EPA announced a freeze on the ethanol mandate, and corn prices fell from $8 to $4.

The thing that makes this an interesting application of supply and demand is the notorious 12-year cattle cycle.  The only way to increase supply in the long run is to hold female cows off the market, thus decreasing supply in the short run, and driving up price.  With corn prices falling, farmers saw increasing profit in cattle, so they initially held female cattle off the market, driving up price and profit.  But eventually, prices (of cattle) follow costs (of corn) down.  As cattle become less profitable, farmers reduce the size of their herds by slaughtering more heifers.  This further decreases price.

It looks as if Landstreet's bet has paid off:
Just yesterday, expecting sharply lower beef costs (COGS) to benefit earnings, I bought stock in Carrol’s Restaurant Group (TAST) and it’s up 12% today. The same thing happened to Restaurant Brands International (QSR), owner of Burger King and Jack in the Box (JACK). Restaurant earnings continue this week with, Fogo de Chao reporting after the close today, Wendy’s (WEN) tomorrow morning and Shake Shak (SHAK) reporting Wednesday after the close.
And what can we expect in the future?
I expect cattle futures to suffer another leg down while next earnings season will be another good one for protein heavy restaurant stocks.

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