This Important Restaurant Metric May Signal Even Worse Times Ahead for the Economy

With no more excuses available, restaurants may be the bellwether for the economy.

Jul 15, 2014 at 12:06PM


Uh-oh. The realization that poor restaurant performance has not been due to weather may at last be sinking in, and analysts may finally have to admit that a lousy economy is serving to drag the industry down.

The latest numbers from the Black Box Intelligence and People Report show that same-store sales at restaurants open at least a year turned negative in June, while traffic at those stores continued its downward drop. The industry hasn't posted a single quarter of same-store traffic growth since the recession. Further, with second-quarter 2014 comps barely inching 0.3% higher, it calls into question whether the recovery Wall Street was expecting in the back half of the year will actually materialize.

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Source: Black Box Intelligence and People Report, and Nation's Restaurant News.

From restaurants to clothing stores, the harsh winter weather allowed retailers to lay blame on the supposedly strange "snow in winter" phenomenon as the cause for all their malaise. McDonald's (NYSE:MCD) said "severe winter weather" was partially to blame for a sharp drop in comps in January, Wal-Mart pointed the finger at "eight named winter storms (that) resulted in store closures" as the cause of its poor performance earlier this year, and carmakers Ford and General Motors said they saw sharp declines in monthly sales because of "extreme weather" patterns.

Even Janet Yellen at the Federal Reserve sought to misdirect attention from the shabby state of the economy by blaming disastrous first-quarter results on Old Man Winter, numbers that were most recently revised sharply downward again, this time to a near 3% contraction, as opposed to the slight expansion that was originally reported.

But with the second-quarter restaurant numbers now also showing persistent weakness -- weakness that was evident last year but was ignored for a variety of excuses companies used en masse to hang their hats on -- it's clear the industry has run out of excuses, and that doesn't bode well for the rest of the year.

The Black Box report goes on to note that over a two-year period, customer ticket values have grown at more than 2% in the second quarter, suggesting that whatever gains restaurants are making is the result of rising prices, not more people who are going out to eat. Even so, they're not fully benefiting from the increases, because falling traffic is offsetting the gain.

Now restaurants are caught in a dilemma of higher input costs. Beef and pork prices are at record levels, and now poultry, which has enjoyed higher demand as a result, is seeing its prices go up, too. Restaurants such as Chipotle Mexican Grill (NYSE:CMG) are being forced to raise their prices to compensate for the greater costs for meat and commodities, a yellow flag that it may cause consumers to pull back even more from eating out.

According to restaurant supply chain co-op SpenDifference, just about everything is more expensive:

  • Cheese, butter, and whey cost 15% or more than they did last year.
  • Beef prices are 15% higher.
  • Pork sausage is up 21%, though pork bellies, which are used for bacon, are only 2% higher, but that's after a year that also recorded record high prices.
  • Liquid egg whites have surged 57% over 2013.

The only bright spot is corn, where prices are falling. Although that would normally help poultry producers increase their supplies, the world's biggest chicken breeder, Aviagen Group, reports that it messed around with its roosters' genetics and caused them to overfeed, resulting in lower fertility. Sanderson Farms (NASDAQ:SAFM), which is the third largest poultry producer in the U.S. and one of Avigen's biggest customers, said 17% of its eggs failed to hatch (15% is the normal failure rate) and the USDA cut its egg production rate for 2014 by 75% from the long-term average because there's a short supply of breeder birds.

Yet unlike McDonald's, which is suffering from both lower comps and traffic but may need to raise prices as much as 3% this year to compensate, further affecting sales and profits, Chipotle continues to gain. Analysts conducting channel checks recently found that the chain's price increases are higher than the average 5% to 6% increase but aren't affecting traffic at its restaurants. 

That's probably because it's the leading chain in the resilient fast-casual dining segment, the only industry niche that's consistently been able to record any growth for the past few years. But the new numbers coming out may call that resilience into question, as there may be only so far consumers are willing to go in paying more at the register.

But even if a Chipotle can weather the storm, other restaurants in the fast-food, casual, or family dining segments may not fare so well. And as more retailers in and out of the industry own up to the fact that there are no more excuses to use, the economic harm will be all too apparent. Investors, therefore, may want to tread carefully before putting any of their money into this ailing sector, no matter how cheap stock prices may look.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, Ford, General Motors, and McDonald's and owns shares of Chipotle Mexican Grill, Ford, and Sanderson Farms. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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