Article

Restaurants feel economic pinch

Operators scale back locations as consumers tighten wallets.

February 4, 2008 by Valerie Killifer — senior editor, NetWorld Alliance

While consumers tighten their wallets and analysts weigh in, fast-casual restaurant brands are taking action against current economic conditions.

 

Brands such as Starbucks and Pick Up Stix — plagued by underperforming locations across the United States — are cleaning house in an effort to decrease operating costs.Starbucks announced Jan. 7 the closing of approximately 100 locations this year, while Pick Up Stix announced in January the shuttering of 26 locations throughout California, Arizona and Nevada.

 

The industry is experiencing a "perfect storm" of economic issues, said Morningstar analyst John Owens, and casual-dining chains are experiencing the first industry challenges.

 

According to Wachovia Capital Markets LLC analyst Jeff Omohundro, the casual-dining segment has the weakest position in the macro-environment — aspects of the economy companies can't control, such as wage and food cost increases.

 

"In our view, the sales growth for the casual-dining segment will likely be constrained in 2008 given ongoing consumer spending pressures and potential trade down to the fast-casual and quick-service sectors," Ohohundro said in a January equity research report. "Additionally, we expect pricing pressures from elevated food and labor costs to challenge casual-dining operators as they may not be able to raise menu prices in a tough spending environment."

 

While Wachovia lowered its valuation for concepts such as O'Charley's Inc., Brinker International Inc. and Darden Restaurants Inc., it increased to outperform Red Robin Gourmet Burgers and Texas Roadhouse.

 

In the fast-casual category, chains such as Panera Bread, Starbucks and Caribou Coffee have had stock prices drop more than 40 percent. Panera Bread's price experienced a 43-percent decrease from its 52-week high, and Starbucks, Caribou Coffee and even Chipotle have seen a 45-percent, 68-percent and 25-percent drop, respectively.

 

Owens said despite Caribou's large decline, the specialty-coffee market is growing, which should give the struggling chain ample opportunity to grow and recover.

 

"It's a challenging time," he said. "But I think strong brands with good balance sheets and with top-notch management teams are going to weather the storm."

 

2008 projections

 

According to Chicago-based NPD Group, for the year ended November 2007, meals purchased at fast-casual outlets in the United States increased 12 percent.

 

While consumers may be trading down to quick-service establishments during the current economic downturn, the impact to fast casuals may be slight.

 

David Tarantino, an analyst at Robert W. Baird & Co., said the increase in operating costs has impacted fast-casual menu prices, but restaurants such as Panera Bread and Chipotle — and others that rely on quality ingredients — are not skimping on quality in an effort to pinch pennies.

 

"They're not changing their marketing programs from what we can see," he said.

 

For brands on the growth track, the industry shift means a more methodical approach for brand expansion.

 

McAlister's president Phil Friedman said current commodities prices are "certainly" hurting the chain. "We're feeling pressure across the board," he said; however, the company is working with suppliers and relying on its existing relationship with consumers to stay ahead of the game. Traffic counts have stayed relatively steady and the chain has not had to dramatically increase menu prices.

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"What's really helping us is we completed a remodel program and grew 15 percent from the remodel," Friedman said. "So, we're going into a bad situation with the remodel complete."

 

Although the National Restaurant Association has forecasted 2008 industry sales at $558 billion, growth for the industry is moderating, said Hudson Riehle, senior vice president of the National Restaurant Association's research and information services division.

 

"When we were doing the 2008 forecast, we knew that the first quarter of 2008 was going to be a challenging environment. But, nothing has occurred so far to make us re-evaluate the underlying (estimate)," he said. "The industry really has become much more essential to consumers' daily lifestyles now than any other point in time. Consequently, consumers are reticent to change their frequency patterns as well as alter their lifestyles fundamentally."

 

Indeed, the industry's overall economic impact is expected to exceed $1.5 trillion this year. And the NRA also is forecasting 945,000 individual restaurant locations across the United States.

 

"The fact is, consumers not only need the industry more, but also have a natural inclination to patronize away-from-home (establishments) because the price-value relationships remain competitive," Riehle said.

 

According to the NRA, the average household expenditure for food away from home was $2,694.

 

Fight to the finish

 

While not wanting to skimp on quality, fast-casual operators will lean toward more value-priced menu options, such as combos and other deals, to keep customers walking through the door.

 

Riehle said because of the tighter economic conditions, consumers have a very distinct impression of the price-value relationship based on prior restaurant experiences.

 

"If they feel a price is not fair, they are quick to vote with their feet," he said.

 

Restaurant operators should respond at the national and/or local level to keep and continue brand awareness efforts.

 

"In softer economic times, a natural inclination is to basically manage costs much more effectively, and that makes sense," Riehle said. "But, in softer economic times, it's important to highlight the proportion of resources that need to be allocated toward marketing, advertising and local messaging that need to stepped up because the need is there to really act as a catalyst to spur that indecisive consumer toward turning to your brand."