Lower food costs to make everything from hamburgers and pizza to popular breakfast items may have helped restaurant operators in the second quarter. But there's less certainty this deflation will dish savings for the remainder of the year as chains face upward wage pressure.
"Prices were some of the lowest levels in four years," said David Maloni, chief commodity strategist at the American Restaurant Association. "Egg prices are declining... cheese and chicken prices are attractive."
In the second quarter, food costs averaged down more than 15 percent on a year-over-year basis, according to the Restaurant Commodity Inflation Index tracked by the ARA. That marked the fourth consecutive quarter of double-digit deflation when compared with the year-ago period.
Egg prices tumbled 64 percent in the second quarter from the prior year, while dairy fell 20 percent and cheese dropped 12 percent, according to researcher Evercore ISI. These commonly used commodities can represent a significant savings for family-restaurant companies such as Denny's or DineEquity, which have a big portion of their business skewed to the breakfast crowd.
"Commodities continue to benefit margins with the breakfast (restaurant) day-part benefiting the most," Evercore analyst Matt McGinley said in a research note published Tuesday.
The Evercore analyst indicated that restaurant industry same-store sales "appear to have slowed" and that consensus earnings estimates for next year maybe a bit too optimistic due to "persistent labor inflation not fully factored into margins. Overall, restaurant margins are expected to decline in second quarter 2016 as weaker comp growth and wage inflation more than offsets commodity deflation."
Nationwide, wage inflation is hitting restaurants as minimum wages at the state and local level go into effect. They include higher wages that went into effect this month in Los Angeles and Chicago.
Beef prices were down 15 percent in the second quarter from a year ago while chicken prices eased 11 percent, according to Evercore. As for commodity price gainers, pork was up an average 3 percent from the year-earlier period. It followed pork prices soaring around 45 percent in the first quarter.
Morgan Stanley analyst John Glass said in a note last week that chicken wing prices are starting to come down and added that chicken generally tends to be "10 to 20 percent" of the cost of goods sold for the fast-food operators and some other chains.
Dairy can represent 30 percent or more of the costs at major pizza chains such as Domino's Pizza, and 11 percent or more for Cheesecake Factory, according to Glass. Major coffee retailers such as Starbucks and Dunkin' Brands have roughly 5 percent or more exposure on the commodity side to dairy. Commodity costs for coffee dropped in the second quarter from a year ago but were up slightly during the month of June and Arabica coffee futures trended higher in early July.