If inflation doesn't already loom large in investors' minds, it should. Increasing commodities costs will further complicate business for many consumer-facing companies, particularly in the restaurant industry. Investors should check the menu carefully before digging into these stocks.
Fast and in fashion
McDonald's (NYSE: MCD ) first-quarter net income increased 11%, to $1.21 billion, or $1.15 per share. Revenue increased 9%, to $6.11 billion, and global same-store sales increased 4.2%. European comps were the bright spot, increasing 5.7%; U.S. comps rose 2.9%, and Asia Pacific, Middle East, and Africa same-store sales jumped 3.2%.
Yum! Brands' (NYSE: YUM ) strength in China deflected its U.S. businesses' weakness. Net income increased 10%, to $264 million, or $0.54 per share. Total sales increased 3%, to $2.05 billion, but comps were a mixed bag.
Many investors have gravitated to Yum! Brands because of its China exposure, and a 13% surge in same-store sales there didn't exactly hurt that thesis. However, not all of Yum!'s quarter proved quite so tasty.
The company's U.S. business, which includes KFC, Taco Bell, and Pizza Hut, isn't faring so well. The company admitted to an unexpected 13% decline in U.S. profits, weighed down by commodity inflation. Yum! also said "false claims made about our food quality" caused negative publicity that contributed to significantly stunted sales at Taco Bell. The well-publicized lawsuit pertaining to Taco Bell's meat has since been dropped.
Costs are creeping up
Investors should exercise discrimination as they assess restaurant stocks. Yum! Brands shares surged on the earnings news, yet it missed analysts' quarterly profit expectations by a penny. Its 1% decline in U.S. comps should have tempered investors' China-driven enthusiasm a bit.
Profit margins are the big story at restaurant companies, including Chipotle (NYSE: CMG ) , which reported earnings last week as well. Investors choked on that stock, even though difficulties in margins touch all restaurants right now.
McDonald's discussed rising costs, too, and expects that trend to continue. Mickey D's predicts a 4% to 4.5% increase in food costs in the U.S. and Europe this year. It's already increased menu prices by 1% this year, and it may have to do so again.
Rising food prices and the challenges they present are hardly limited to these companies. They're not even limited to the restaurant business. Giant Kimberly Clark (NYSE: KMB ) cited inflation and impending price hikes in its declining quarterly results today.
Clearly, when increased costs for household necessities stretch consumers' pocketbooks too thin, the restaurant industry could suffer greatly. Eating out is always a relatively easy expense to eliminate.
Defense is on the menu
Whatever challenges face McDonald's, Yum!, and Chipotle, they're still safer stocks than those involved in the more expensive side of dining, like Ruth's Hospitality (Nasdaq: RUTH ) or even Ruby Tuesday (NYSE: RT ) . Last quarter, Ruth's hinted that it might have to raise prices due to increasing beef costs, while Ruby Tuesday reported an unappetizing and uninspiring quarter early this month.
The cheap-and-fast players' existing bargain mentality could give them a defensive edge as many consumers spend less on higher-end evenings out. Still, investors should factor in the impact of higher commodities costs on consumer spending, and on restaurant companies in general, before buying in.
What do you think? Use the comments box below to let us know whether you think there are good opportunities in this segment, or whether you wouldn't touch it with a 10-foot fork right now.
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