Article

Higher menu prices boost earnings, but can it last?

Operators prepare for higher food costs as droughts continue in the Midwest and overseas competition threatens the U.S. food supply.

July 30, 2012 by Valerie Killifer — Editor, FastCasual.com

In their second quarter earnings reports, executives from both Panera Bread and Chipotle discussed their implementation of menu-price increases. The strategy led to higher average ticket sales for both chains and offset food-cost increases due to fluctuating commodities markets.

The companies' move to raise menu prices did not negatively impact sales growth for either chain but it did highlight two important issues facing the restaurant industry: an overall economic slowdown and a rise in food costs.

Chipotle's CFO Jack Hartung said the company saw a same-store sales slowdown in the second quarter and he attributed that slowdown to consumer spending in general.

"We're not seeing anything that's specific to markets," he said. "It seems pretty broad based."

While major chains need to raise menu prices to keep up with inflation, The Motley Fool analyst Jason Moser said fast casual restaurants must be mindful of how those increases come across to consumers.

"Chipotle and Panera both possess some pricing power thanks to the quality of the food and experience. As such, they are able to pass along incremental price increases that customers will pay; however it’s a fine line they must be careful not to cross," Moser said.

Panera Bread's Co-CEO Bill Moreton said that while the company has increased menu prices, the increase is not a "significant" price beyond the rate of inflation.

"What we have seen and what we have done is we've continued to offer people products that they get to choose and that they believe is worth the money we charge for that," he said.

In the case of Chipotle, the menu price increases helped the chain balance rising costs in other areas. Food costs in its 2012 second quarter were about the same as Q1, but were lower when compared to the same period last year "due to higher menu prices."

Rising food costs

One factor driving menu prices increases is the rise in food costs – specifically in regard to corn, cattle, poultry and dairy.

The National Restaurant Association's 2012 Industry Forecast reports that food costs are projected to remain elevated for the remainder of the year.

According to the U.S. Department of Agriculture, corn and soybean levels have dropped to their worst conditions since the drought of 1988, causing investors to purchase supply ahead of any additional shortfalls.

Bob Bresnahan, founder of Chicago-based Trilateral Inc., said the United States was on target to produce in excess of 14 billion bushels of corn this year. However, that number has been reduced to just under 12 billion bushels. That impacts not only the price of corn and soybean meal, but also the price of purchase for cattle, hogs and chicken.

Bresnahan said the cost of proteins will remain high through the remainder of the third quarter and well into the fourth, with reprieve coming late in 2012 and early- to-mid 2013 as farmers liquidate their supply.

"In terms of full-year inflation, while costs have been relatively stable overall so far this year, the recent extreme weather will likely put pressure on our food costs later in the year and into 2013," Hartung said.

In addition to an increase in the price of beef, he said pressure will come from the dairy and chicken markets.

Yet one unknown variable is the role China will play on the U.S. food supply.

If China decides to purchase its pork from the U.S., rather than import its supply of corn and soybean meal used as feed, the pork supply available to U.S. restaurant operators could be diminished.

Additionally, China is expected to import 3 million tons of corn in the 2011/2012 market year, more than triple the amount for the same period last year. The substantial increase is based on China's population eating more meat than in previous years' and its industrialization, which has decreased usable land for crops.

Fast casual operators in the U.S. can offset some of the increases by focusing on their loyalty programs and their value propositions.

"Whether it’s a dollar off your coffee or a free bagel, it’s something that strengthens the relationship for the long-haul," Moser said.