Casual restaurants burned by inflation
Posted
Jul 21 2008, 04:41 AM
by
Anthony Mirhaydari
Rating:
It's not just health-conscious diners who should be concerned about restaurants like Cheesecake Factory, Red Robin Gourmet Burgers, P.F. Chang's China Bistro, and Texas Roadhouse.
With food and fuel inflation at critical levels, investors should be worried about the health of the entire casual dining sector, including companies like Darden Restaurants and Brinker International, operators of Olive Garden, Red Lobster, and Chili's.
All must contend with rising food prices, especially for meats, seafood, and dairy products at a time people are drastically reducing discretionary driving and rediscovering the joys of eating in. A recent Nielsen survey of 50,000 consumers found that 52% are eating out less often.
This has happened before. Research by Morgan Stanley analyst John Glass notes that during the inflationary period of 1979 and 1980, traffic fell nearly 4% as consumers were forced out of restaurants and into grocery stores. In fact, although limited somewhat by data availability, Glass was able to uncover a moderate statistical relationship between gas prices and restaurant traffic.
Traditionally, restaurants were early-cycle performers that perk up just as a recession reaches its nadir. But by all indications, this won't be a typical recession in either length or severity for a majority of Americans. And a comparison to the last consumer-led recession of 1990-1991 doesn't offer much solace to current shareholders. Those were the good old days of cyclicality: Margins actually expanded as a slowing economy brought down food and labor costs.
Now, food prices are decoupling from the American consumer; to be determined by Asia's appetite for protein and petroleum. Labor costs are on the rise as federal minimum-wage legislation continues to be phased in over the next two years.
There is also the issue of artificial demand and oversupply. Empowered by swelling home equity, consumers enjoyed restaurant meals at an unsustainable rate during the go-go years between 2005 and 2007. During that time, restaurant sales grew faster than disposable income by $13 billion cumulatively. Decades of growth in per capita restaurant visits has hit a ceiling around 210 meals per year -- people just aren't willing, or are unable, to eat out more than that.
Corporate management, in a bout of unfortunate optimism, assumed all this new business would continue indefinitely. So they eagerly responded with new locations and new dining concepts like overzealous homebuilders. Not only are we faced with a glut of homes, but a glut of restaurants as well.
These new competitive pressures make any effort to pass on costs an exercise in futility. Cost-conscious consumers will balk at menu hikes, reducing traffic and further contracting margins as economies of scale are unwound.
Although valuations are tempting at these levels, I recommend avoiding the sector until underperforming restaurants are closed, real wages recover, and energy prices -- and therefore food prices -- come back down to earth. Plus, after a few more months of home-cooked meals, people might pay any price to order off a menu again.
(Disclosure: I don't own shares in the companies mentioned)
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