Three Trends on Restaurant Executives' Minds in 2016
Restaurant earnings held some surprises for investors in Q1, including some success stories amid general uncertainty around consumer confidence. But by the start of Q2, investors and even some restaurant company chief executives were even more surprised by unexpected softness in a sector where most macro indicators seemed to be heading in the right direction.
In general, we've found that CEOs like to have a good idea of what might drive or hinder their companies' success. That's why, each month, Baird conducts a survey of executives from U.S. restaurant industry companies to gauge underlying trends. Our April survey included responses from c-level executives (CEOs, CFOs, etc) at 32 restaurant chains, including private chains and franchises of publicly traded chains, with aggregate annualized revenue near $7 billion. It also provided some perspective on the factors the restaurant industry will be watching and weighing for the balance of the year.
As vital as a blood-pressure reading, same-store sales tell retail chains and their investors what portion of growth is coming from stores that have been open more than a year. Final results from our most recent survey indicated April comps were near +2.5-3.0%, though that number was influenced by one survey participant within the Quick Service Segment (QSR) that experienced robust improvement due to what appears to be company-specific and not sector trends. On a sales-weighted basis (including all participants), 40%of the sample (15 chains) pointed to better trends in April relative to March, while 47% (13 chains) pointed to softer trends sequentially. The data looked even weaker when factoring out the one participant that had unusually good trends in April.
A number of reasons were cited for softer performance in the March-April timeframe, including weather that, while historically appropriate for spring, represented a comedown from an unseasonably warm winter for most of the United States. But Malcolm Knapp, the creator of the Knapp-Track index – a widely watched indicator for same-store sales in the restaurant industry that we cite in our survey – had another theory.
Knapp told CNBC late in Q1 that he believed campaign rhetoric from the current presidential election cycle, and specifically talked about the state of the economy, might be partly to blame. And there may be other statistical support for this theory. Consumer confidence, as measured by the University of Michigan Consumer Sentiment Index, fell from 91.7 in February to 90 in March and dipped again to 89 in April. This was despite relatively low, stable unemployment and improving wage growth as reported by the U.S. Department of Labor at the beginning of April. Granted, there were other factors at play – including an uptick in gas prices (see below), but it stands to reason that consumers' spending habits are shaped by their perception of the economy's health, which has been a central theme of both the Republican and Democratic campaigns in a particularly attention-getting primary season.
If Knapp is right, the political process could remain a headwind until November, when stocks in general have tended to experience a life in election years as related uncertainty abates.
Another factor worth noting is that the May reading for consumer confidence further decreased from April, coming in at 92.6. How that reading may actually impact spending remains to be seen.
The Price of Gas
Lower gasoline costs have provided a tailwind for consumer spending and restaurants – particularly in the limited-service segment – in recent years. And while prices are still down year-over-year from 2015, the chart below shows the recent trend has been increasing prices at the pump week-over-week.
Average national gas prices in April were $2.03/gallon compared to $1.86/gallon in March. By mid-May, average gas prices had risen $0/43/gallon since the beginning of March. The fairly sharp sequential rise in gasoline prices may be causing consumers to pull back on overall spending as their monthly budgets are readjusted.
The Cost of Doing Business
Another pressing factor for restaurants is recent and potential future labor inflation.
In the wake of minimum wage increases i states across the country, on May 18 the Department of Labor published new rules updating the regulation of overtime pay. This change increased the fixed salary threshold for overtime pay eligibility from $23,660/year to $47,476/year, meaning employees working more than 40 hours a week for a fixed salary of less than $47,476 are now eligible for overtime pay.
The majority of respondents indicated expectations for some level of inflation related to the new rules, with the average projected increase for gross inflation (i.e., prior to pricing or other offsets) for all chains combined near +1-2%. We also asked participants about their planned strategies to offset anticipated labor inflation. As shown below, respondents pointed to a number of planned actions.
The Case for Selectivity
Based in part on our survey results, Baird believes the risk profile for restaurants is somewhat elevated given softer demand trends in March and April. While we are cautiously optimistic that some of the factors impacting recent demand will prove transitory, and we have been reassured by some signs of better trends in late April and early May, we continue to believe a more selective buying approach to the group may be warranted in the short run.
We would lean toward increased exposure to companies that possess strong internal demand drivers and/or defensive business models, while reducing exposure to companies that would be most vulnerable to a pullback in discretionary consumer spending.
These data are only a sample and may not be representative of overall industry trends. None of the responses apply to international markets, so the survey is only partially relevant for global operators.