Inflation and restaurants is not a new theme, but add gasoline prices and the mixture could be explosive.
In the recent round of earnings, company after company talked about rising food costs, and analysts tweaked their numbers.
But after talking to analysts and industry insiders, it’s clear the true potential impact of rising food costs on the bottom line and the prospects of unexpectedly higher gas prices on the top line have not yet been fully factored into the stocks.
“Most restaurant chains are significantly understating inflation plus the sales impact from rising gas prices,” says Allan Hickok, head of the consulting firm of Restaurant Retail Strategies in Minneapolis. “It’s a double whammy that’s not good.”
But even without the sudden rise in gas prices, Hickok, a former analyst and restaurant CEO and current restaurant board member, says he believes companies and analysts are living denial.
Consider that even after acknowledging sharply higher pricing, with the overall market about 3% off its highs:
Chipotle, up around 148% at its 12-month peak , is just 6% in recent weeks.
After doubling over the past year, DinEquity (Applebees, IHOP) is off just 7% .
McDonalds, up 14% at its highs, is off just 6% .
And this is with companies making their observations with only a peek into the first quarter. “Things were looking squirrely,” Hickok says. “Hope, as you know, is a strategy. As far as I’m concerned the ‘hope’ is that this will all settle down. But it’s getting worse.
“It’s Pollyannaish to conclude that what we have just seen is just a little spike of a very short duration. Things never work out that way.”
One fast-food operator I know in Florida told me this: “As we look to competitors, we are seeing restaurants that have begun passing the prices along to the consumers or maybe just taking advantage of mildly improving economy to raise prices a bit or at least discount less.”
Among those leading the charge, he says, include McDonald’s, which said on its recent earnings call that it expected to selectively raise prices throughout the year. Hedging on coffee has allowed Starbucks to absorb most price increases – for now.
And Chipotle, which believes it has more pricing power than most restaurant chains, is taking a wait-and-see. Speaking on the company’s earnings call, CFO John Hartung said: “While we continue to believe we have as much if not more pricing power than other restaurants, we plan to hold off on any menu-pricing decisions until later in the year, which will allow us to see how inflation plays out on a sustained basis and allow us to see how consumers react to price increases from other restaurants and grocers.”
No wonder analysts are gun-shy about raising red flags.
“I don’t see where people are categorically ringing the alarm bells,” Hickok says. “They don’t think it will be as bad as it is. Most analysts haven’t revised their cost-of-goods-sold estimates in a reasonable way, even though we know what is happening. Until that happens, and estimates go down, it’s just chatter. And to think it’s baked in [to the stocks] is wrong, because it’s not.”
Even if chaos in the Middle East wasn’t happening, Hickok says he would be saying the same thing. “All restaurants are vulnerable because they all buy food,” he says. And food costs have been spiraling higher.
Meanwhile, for now, the general themes among restaurants is that business has been hurt a bit by weather, cost pressures are a bit worse than expected but they’re cautiously optimistic because of the economy. “Nobody is throwing in the towel in the first quarter yet because nobody wants to be the first to do so,” Hickok says.
You can just feel the indigestion coming.
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