Retail restaurants in the casual, fast-casual, and quick-service sectors are facing pressures from rising food costs, especially the cost of beef. The Bureau of Labor Statistics recently reported that the Consumer Price Index for meats, poultry, fish, and eggs rose 1.5% in April.
Over the last three months the CPI for these foods is up 3.9%, while the index for meats rose 2.9% for its largest increase since November 2003. Finally, the index for food away from home rose 0.3% in April, the third-straight such increase, and has increased 2.2% over the last 12 months.
The high price of beef will likely be in play going forward. According to a recent survey conducted by Bloomberg, the spike in beef costs is due in part to the size of the US cattle herd falling to its lowest level in 63 years. This could force the price for steak and ground beef to climb by as much as 5-10% and 10-15%, respectively, over the next two years.
Why this matters
Put simply, consumers will have to pay premium prices for beef for the next year or two. However, the question remains as to whether diners will eat in or cut back on per-ticket orders. That being said, retail restaurants will invariably pass higher food costs to their guests.
In fact, fast-casual chain Chipotle Mexican Grill (CMG 1.71%) recently announced during its last earnings call that it will raise prices in the "single digits" this quarter to offset higher food costs.
Jack Hartung, the company's chief financial officer, said that "beef prices are expected to continue to move higher as supply remains tight."
Chipotle's management believes, however, that the company will continue to perform well regardless of the menu price hikes. The chain also touts its reputation as environmentally conscious in light of its leadership regarding the labeling and use of genetically modified organisms.
Alex Spong, Director of Investor Relations, stated during the call that Chipotle "eliminated virtually all of the GMO ingredients in our food."
"Our corn and flour tortillas are the only foods we currently serve that are made using ingredients that contain or could contain trace amounts of GMOs and now we're testing new non-GMO recipes for these tortillas," Spong said.
While this could help continue bringing diners to its doors, the proof is in the earnings. Chipotle has also resisted menu price increases until this announcement. Raising menu prices actually could help support profits, provided that customers are not put off by the price hike. Be that as it may, Chipotle is a very pricey investment, and some investors might find better value by dining elsewhere in the sector.
Other restaurant chains respond to rising beef prices
The Cheesecake Factory (CAKE 6.49%) announced menu price hikes of at least 2% a year back in February before the CPI reported rising beef prices in March and April.
The Factory recently reported its financial results for the first quarter of fiscal 2014, which ended on April 1, 2014, and reported total revenue of $481.4 million for the period compared to $463.0 million in the year-ago period.
Like other chain restaurants, The Cheesecake Factory and its Grand Lux Cafe line saw their sales rise by a mere 0.9% during the quarter, due in-part to the harsh winter weather. However, the company does not seem too worried about rising beef costs and the planned menu price hikes should help Cheesecake continue to bake, so to speak.
Chairman and CEO David Overton argued that the chain's extensive menu, high-quality foods and service level allow for a "unique dining experience for our guests." Overton believes that Cheesecake will continue to deliver "dependable comparable sales results over a sustained period of time."
At the other end of the retail restaurant table, Sonic Corporation (SONC +0.00%) rolled out a 2% price hike in Nov. 2013 to offset higher food and commodity costs. The quick-service chain is strong in a number of ways.
Source: Mike Mozart, Flickr
Sonic saw earnings per share improve by 16.7% in the most recent quarter compared to the year-ago quarter despite the harsh winter weather and rising food costs. The company also has a history of solid earnings-per-share growth.
Finally, Sonic's present share price of $20.30 is off of its 52-week high of $23.56, and its forward P/E of 20.71 is well below today's price-earnings ratio of 29.90. This indicates that some solid share price growth is on the grill for 2014, regardless of slightly higher bills for diners.
The bottom line
Rising beef prices are here to stay for at least the next two years because of the smaller cattle herd. However, diners will continue to eat out rather than cook at home, in my opinion. The question remains as to whether they will cut back on their per-ticket orders.
In any event, investors should pick and choose their dining locales carefully as the rising beef prices take hold; chains like The Cheese Factory and Sonic Corporation appear well positioned to weather the food-cost storm.
