(Photo credit Michael Nagle)
There's a troubling trend brewing in the restaurant world -- and it's not the sudden explosion of meatless meats. No, it's something far more problematic to restaurants' bottom lines and, ultimately, survival: according to two new research notes, the industry could be headed for a recession.
Consumer confidence is steady, earnings in the food sector are not all doom and gloom and recent analyses of restaurant performances in May found checks accelerating to their highest growth levels since 2013. So dining rooms across the country are not exactly imploding. But according to two new pieces of research out Tuesday, a bevy of trends -- including historical restaurant cycles, a glut of supply and increased competition from independent operators -- are pointing to significantly choppier times ahead.
"Today, we adopt a bearish outlook for restaurants as we confidently believe that, at a minimum, the simultaneous 1.5% to 2% deceleration of restaurant industry comps across all categories during the second quarter of 2016 within our most recent Stifel sales survey reflects the start of a 'US Restaurant Recession,'" writes Stifel analyst Paul Westra in a note that downgraded 11 different restaurant stocks -- including Chipotle (which he downgraded from sell to hold), Darden (also sell to hold),
"Our final second quarter Stifel sales survey results suggest that the restaurant industry’s second quarter industry-wide comp was +0.7% (versus the +1.0% consensus estimate) and, as such, we believe that the average restaurant company will report a second quarter -0.3% comparable store sales miss," he says.
Westra doesn't stop there; he even goes as far to suggest that a restaurant recession could be a harbinger for a U.S. recession in 2017.
"From our restaurant-industry only perspective, when industry category comps decelerate simultaneously by -2% to -3% (like in the second half of 2000, first half of 2007 and now in the second quarter of 2016), then the lower 'new-normal' same-store-sales trend has lasted for at least two years -- typically the year-before and year-of a U.S. recession," he writes. "Accordingly, today, we adopt a below-consensus two-year second half of 2016 through first half of 2018 industry-wide comp outlook of +0.50% while also incorporating a below-consensus outlook of relative pricing power as price-wars typically ensue during dining-out slowdowns."
His was the more extreme of the two bearish notes released Tuesday. The other note, from Andy Barish at Jefferies, struck a less alarmist tone.
"We believe the industry has at least 18 months of challenges ahead in terms of softer same store sales and higher labor costs because of capacity growth and labor tightness, a year after the stock peak in summer ’15," he writes, noting that this conclusion comes after an "extensive" study on restaurant supply and its impact on same store sales growth and labor.
One of the biggest pieces of evidence Barish points to is a supply glut. Thanks to an influx of capital from 2010 to 2016, restaurant unit growth has gone back to 2007 levels. Only this time there are even more smaller chains and independent/chef-driven concepts fighting for diners' dollars, so supply is even higher than it was at the last peak in the cycle.
"Our sense is that the amount of supply that has come into the market over the past few years is beginning to impact traffic trends, most notably in Texas and Colorado, where conditions have deteriorated with slower energy-related activity and supply growth," Barish says. Ultimately, he adds, "we think excess capacity in the industry is keeping same store sales growth from accelerating despite other macro tailwinds" like job growth and wage inflation.
Wage inflation, however, works both ways: higher labor costs as the result of minimum wage hikes could eat into restaurant margins. And within this environment, Barish sees casual dining chains -- like
"We have reduced our earnings growth expectations by nearly half across our casual dining coverage as we expect restaurants within this space to feel the most impact from rising labor headwinds and slowing commodity tailwinds given the structural disadvantages within these predominantly company-owned business models and increasing competition within the category as well as other category players," he says. "We believe margins across the casual dining space could continue to compress well into 2018."
As the result of this outlook, Barish and his team downgraded a number of casual dining names in Tuesday's note, including Texas Roadhouse (taking it from hold to "underperform), Red Robin (from buy to hold) and Ruths Chris Steakhouse owner Ruth's Hospitality (buy to hold).
Barish isn't entirely bearish; he notes that there are several fast casual chains that could prove good investments in the landscape he's described. His picks: Dave & Buster's (two-thirds of its revenues are from games and bar businesses, which have higher average gross margins), Fogo de Chao (tipped employees provide both back and front-of-house duties, putting overall labor expenses in the low 20% range) and Panera Bread (which has made technology investments to help get more productivity out of its labor force).
