It only took Chipotle Mexican Grill (NYSE:CMG) thinking out loud about dropping guacamole from its menu because of rising avocado prices to generate fear of a looming "guacalypse." A world without the dip was apparently one not worth living in.
The fast-casual dining chain was able to calm frayed nerves by saying it was only speculation, and it had no intention of taking guacamole off its menu, but the consternation it caused might pale in comparison to the potential riot that would break out if burger joints squeeze out hamburgers in favor of chicken sandwiches because of record-high ground beef prices.
McDonald's recently rolled out chicken wraps with cucumbers, ostensibly because they're healthier, but you'll also find more chicken club sandwiches and larger McNugget meals, too. Wendy's is also using the guise of a healthier, gourmet menu to push its Crispy Dill Chicken Sandwich, Pretzel Pub Chicken sandwich, and Smoked Gouda Chicken on Brioche.
Earlier this year, Burger King reintroduced its chicken fries to much fanfare after saying it would be hawking chicken more aggressively, and it recently unveiled a chicken version of its Big Mac-lookalike, the Big King sandwich. Even Domino's Pizza (NYSE:DPZ) said it wanted to be seen as a "legitimate player in the chicken business" with its Specialty Chicken, which is basically boneless chicken being used as a pizza crust.
Rising costs are ruffling feathers
The rationale, of course, is to contain expenses. McDonald's said U.S. commodity costs rose 3% in the third quarter primarily as a result of higher beef and dairy prices, and Wendy's concurred by saying it suffered a 10 basis point decline in restaurant margins because of a 70 basis point hike in commodity costs, also primarily from beef and dairy.
With beef prices remaining at record levels, not only will we see more burger joints pushing chicken dishes, but restaurants with beef as a primary component of their menu will see their performances impaired.
Texas Roadhouse (NASDAQ:TXRH), for example, a national steakhouse chain, reported a 40 basis point decline in its restaurant margins because of a 4.5% increase in food costs, which outpaced the 4.4% rise in customer traffic it experienced. It anticipates beef prices to stay high throughout 2015 and plans on hiking prices by 1.8% later this month, which it admits is earlier than it normally does.
More price hikes coming
So far, Chipotle has escaped the impact of rising beef prices because it offset them with price increases. Food and beverage costs surged 34% year over year, and those costs comprised 34.3% of its revenues in the third quarter compared to 33.6% in 2013. But comparable-store sales still jumped nearly 20% in the period from a combination of higher customer traffic and an increase in average customer check value from menu price hikes, which it had warned could be as much as 4% to 6%.
Like Texas Roadhouse, Chipotle admits food inflation will likely continue throughout all of next year, but Wendy's thinks it could extend well into 2016. There's a limit, then, to how much customers will be willing pay for a meal before restaurants have to bear part of the burden themselves, or face a customer exodus.
The "headwinds" Wendy's said it encountered this past quarter were due precisely to absorbing some of the higher commodity costs, but we'll see others simply drop items from the menu, as McDonald's did last year when it removed its higher-priced Angus burgers from the menu just as beef prices started to rise.
Eating out is getting more expensive
McDonald's says it wants to keep its prices at or below the inflation reflected in the food-away-from-home index, which currently stands at 2.5%. The burger joint said its U.S. pricing was running only 2% higher this past quarter, down substantially from the 3% level it was at in June, but of course, that put pressure on its margins. The restaurant says it's not going to change in the fourth quarter, either, and if the forecasts for rising beef prices as far as the eye can see are accurate, McDonald's profits are going to be pinched even more.
Drought, disease, and demand are all conspiring to raise beef prices, causing cattle herds to shrink as a result. They started off 2014 at a 63-year low. It's no coincidence, then, that we've seen restaurants start pushing chicken onto their customers more aggressively, though the increased demand has started pushing poultry prices higher, too.
That added emphasis might benefit fast-food places like Popeye's and KFC, but it will also increase the competitive pressures on them, not to mention raise their own commodity costs. The U.S. division of Yum! Brands (NYSE:YUM) chicken chain, which accounts for 25% of its revenues, said system sales were only even with last year in the third quarter, but down 3% over the first nine months.
A game of chicken
Restaurants like Chipotle Mexican Grill that are raising prices are daring their customers to leave. Wendy's, on the other hand, risks profitability by trying to maintain market share through absorbing some of the costs. The rising prices, though, are like a hidden tax on consumers, and the outcome may end up being worse for the restaurants than whatever would happen if guacamole were to disappear from the menu.
Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Texas Roadhouse. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.