Times are tough for the restaurant industry, and even many of the best chains are suffering from rising overhead costs. The use of the frightening words “restaurant recession” started to spread in July after Stifel Nicolaus analyst Paul Westra downgraded 11 restaurant stocks, while saying a deceleration of sales growth, along with rising expenses, was setting up a grim period for the industry. Westra also said an economic recession in the U.S. in 2017 could be the “worst ever” for restaurants, because the likelihood of minimum-wage increases would take away the industry’s usual post-recession labor-cost decline. There aren’t any strong signs of a recession in the works, with the economy continuing to expand slowly and adding 255,000 jobs in July, in nearly every broad category. So, in a positive frame of mind, we decided to look at the S&P 1500 Composite Index to see which restaurant companies were putting up the best numbers. Second-quarter earnings season is nearly over, and 25 of the 27 restaurant companies included in the index have reported their quarterly results. The stragglers are Bob Evans Farms Inc. CA:BOB, which will release earnings for the quarter ended July 31 on Aug. 31, and Cracker Barrel Old Country Store Inc. CBRL, -1.74%, which is expected to announce its results for the quarter ended July 31 on Sept. 14. Analysts polled by FactSet expect a 2.3% decline in same-store sales for Bob Evans, and a 3% increase for Cracker Barrel. We thought it would be useful to do a quick screen for quality restaurant companies that are still showing improvement in three important areas: Of the 25 S&P 1500 restaurant companies that have reported results this earnings season, 11 made the initial cut: We looked at growth of sales per share, rather than revenue growth, because the per-share numbers reflect any dilution from the issuance of new shares, as well as any decline in the share count from buybacks. Gross margin is calculated by subtracting the cost of goods and services sold from revenue, and dividing the result by revenue. No one can predict how high employee-related expenses will rise over the coming years. However, rising costs have already affected net income margins. These margins reflect all expenses: So only six of our initial screen of 11 restaurants improved net profit margins. Going back to our original list of 25 restaurant companies, 13 suffered declines in net income margins. In the July report listing his restaurant-stock downgrades, Stifel Nicolaus’ Westra said the industry had already enjoyed a post-recession decline in labor costs through 2015. Credit Suisse analyst Jason West said in a report in May that he and his colleagues had estimated minimum-wage inflation of about 3% “over the next few years,” but cautioned that “this comes on top of an already tight labor market, rising benefits, likely changes to overtime rules and a ‘war for talent’ in the industry.” But a rise in expenses is already having an effect. Here’s a summary of analyst opinion on the six remaining companies that showed improved comparable-store sales, rising sales per share and improved gross and net income margins: Sentiment is clearly mixed, with majority “buy”ratings only for Starbucks Corp. SBUX, -2.87%. It’s also interesting to see a fairly significant level of “sell” ratings, considering how reluctant analysts are to assign negative ratings. Even though there are plenty of restaurant companies that are still growing, nearly half of them have become less profitable. Analyst sentiment is tepid, considering how positive sell-side analysts tend to be. If analysts are correct in their predictions of continued increases in labor costs, we may well be in for a few years of pullbacks for the sector.
Nearly half of US restaurants have become less profitable with many suffering from rising overhead costs, in a further sign of an impending recession for the industry, Philip van Doorn writes in MarketWatch. Stifel Nicholaus analyst, Paul Westra, recently downgraded 11 restaurants, stating that falling sales are the "canary that lays the recessionary egg," since historically, restaurants have led the stock market lower ahead of previous financial crises.