According to the July consumer price index report, the cost of food away from home increased by the most in a month since 1981, but many restaurants are unable to pass on all of their costs to customers. Middle-tier restaurants, which require large staffs to provide full service but serve a more price-conscious clientele, may be particularly vulnerable. Companies with strong pricing power and fewer labor requirements, on the other hand, may be in a better position.
Another investment opportunity is in the parent companies of franchise businesses, which can be shielded from earnings volatility.
“Another potential hedge in a highly inflationary environment is to own companies that collect rent as a percentage of sales from franchisees while either owning the real estate or paying fixed rate rent (Buy-rated [McDonalds] and [Jack in the Box] both stand out),” according to the Guggenheim note.
In contrast, Deutsche Bank’s Brian Mullan stated earlier this month in a note that the phrase “casual diner” has become a “dirty word” on Wall Street. Mullan did upgrade Bloomin Brands to buy from hold, saying that given its current valuation, the stock should outperform its casual dining peers even if the industry struggles.
Recent job reports show strong wage growth, particularly among lower-income workers, and job openings are at an all-time high, despite the fact that the labor market has yet to fully recover from last year’s recession. And, unlike some commodity price increases this year, wage gains are unlikely to reverse.
“Services prices are more stable and are more likely to be an upside risk. “Wages are the biggest risk there, even though we have a transitory outlook,” said Luke Tilley, chief economist at Wilmington Trust.
Restaurant companies reported skyrocketing food prices in their second-quarter earnings reports.
For example, Kristy Chipman, Ruth’s Hospitality’s chief financial and accounting officer, stated on an earnings call that beef prices were up 27 percent year over year last quarter.
And food price pressures appear to be on the rise in the near future. Donnie King, CEO of Tyson Foods, stated that his company is experiencing “accelerating and unprecedented inflation” and will continue to raise prices for its customers. Texas Roadhouse increased its full-year commodity inflation forecast to 7% after the measure rose 6.5%.
Guggenheim’s Francfort, who noted that restaurant stocks struggled from 2017 to 2019 when the labor market was tight, said that wages are a better predictor of restaurant stock performance than volatile food prices.
“The view has been that labor and topline trends usually drive long-term stock performances more than food costs,” Francfort said. “However, we haven’t seen a really big upswing in food costs in a long time.”
According to FactSet data, Wing Stop, Chipotle, and Domino’s were among the best performing restaurant stocks in the three years preceding the pandemic, when the labor market was strong. Wing Stop and Domino’s both have few, if any, dine-in options for customers in most of their locations, allowing them to operate with fewer employees than some other restaurants.
Meanwhile, restaurant supplier Sysco underperformed those top names but outperformed many of the top casual diner stocks. On a Tuesday earnings call, the company’s CEO, Kevin Hourican, stated that the company had been able to offset recent wage increases with price increases.
To be sure, the restaurant industry’s inflationary costs have been anticipated on Wall Street for some time, so some of the previous winners may have already factored that in.
Chipotle got downgraded
Analyst Brian Vaccaro downgraded Chipotle stock to outperform from strong buy, saying in a note to clients on Monday that the underlying business remains strong.
“We are downgrading CMG from Strong Buy to Outperform due entirely to valuation following the stock’s 37 percent surge in the last six weeks. We are raising our price target to $2,025, representing a 7.5 percent increase from current levels, which is less than the 15% required to maintain a Strong Buy rating, according to the note.
On Friday, the stock closed at just under $1,888 per share, up from $1,550 at the end of June, for a gain of about 21%.
According to the note, Chipotle also has the pricing power to offset its recent wage increases for employees.
“To be clear, we remain very bullish on the company’s near-term fundamentals…. We believe recent menu price increases have encountered little resistance, creating additional store margin visibility (and covering the dollar impact of wage increases announced in June),” the note stated.
Beyond Meat got downgraded
To create 15 different screens that comprised its short ideas, the firm examined companies’ capital creation and allocation, earnings quality, valuation, and sentiment.
Chegg, an education technology company, appeared more frequently than most, landing on six screens. Beyond Meat and Tesla appeared on five screens, while Amazon appeared on four.
Beyond Meat Tesla and Amazon, according to Wolfe, are in the bottom 20% of their sector earnings quality and are among the largest share count increasers with negative free cash flow yields.
Tesla and Amazon are both singled out for having peaking capital expenditures and low cash flow yields.
Beyond Meat has increased inventory and asset growth by more than 10% while accrued expenses have decreased. In addition, the company’s leadership changed in the last year, with a new chief financial officer taking over.