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Be Very Afraid of Restaurant Stocks

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January 24, 2011 – Comments (15) | RELATED TICKERS: MCD

As I mentioned in a post a couple of days ago (link: The Government Really Screwed Up This Time. Here's How You Can Profit From the Mistake), food prices are definitely headed higher in 2011 and this is likely bad news for restaurant stocks.

Perhaps the largest restaurant chain in the world, McDonalds (MCD) just confirmed the tough environment for restaurants in a statement this morning:

The company said its "grocery bill" -- what it pays for the 10 different commodities that account for around 75 percent of its food preparation costs -- is expected to rise this year 2 percent to 2.5 percent in the United States and 3.5 percent to 4.5 percent in Europe.

Europe and the United States are the two top markets for McDonald's.

Executives last year signaled that McDonald's could boost menu prices to offset higher food costs, and several analysts expect those to hit in 2011.

"They will certainly try to pass on those costs," said Peter Jankovskis, co-chief investment officer with OakBrook Investments, which owns shares in McDonald's.

All restaurant operators will be under pressure to raise prices, and analysts said McDonald's size could work to its advantage.

McDonald's sees costs climbing; shares down

This is much worse news for restaurants that aren't as large as Micky Ds.  Not only that, but higher food costs, combined with higher fuel prices *, are going to put some pressure on consumers on 2011.  I'm not exactly going to short any retail or restaurant stocks because it's quite possible that the improvement in the economy that I expect to see this year may offset some of this inflationary pressure, but higher food and energy prices certainly won't help things.

Deej

* While I'm on the subject of fuel prices, what's up with the spread between Cushing oil prices (the one that we mainly look at here in the U.S.) and Brent crude.  When I looked this morning, Brent was over $97 and Cushing was something like $88.  Playing a reversion to the mean arbitrage play might make a nice trade here.  I'm sure that there's a lot of funds out there that are doing this right now.  Of course, this is the sort of trade that Long Term Capital Management used to make all the time, and they eventually blew up :).

15 Comments – Post Your Own

#1) On January 24, 2011 at 12:16 PM, magnetpal (< 20) wrote:

People can not stop eating I suppose:). So I think restaurants will start increasing their prices.Gas then food, people will slowly start realizing the pain of inflation.

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#2) On January 24, 2011 at 12:20 PM, TDRH (99.48) wrote:

Rising inputs for restaurants and decreased discretionary income for consumers spells trouble for the industry.   It will be interesting to see how it shakes out.  

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#3) On January 24, 2011 at 12:21 PM, alstry (36.57) wrote:

Actually...McDonalds is a franchise based model so for the franchisor, the rise in price actually raises revenues...but for the franchisee who is unable to pass on the costs to the consumer...he/she is screwed.

Now if you factor the trend towards coupons like Groupon and others, the collapse in sales and/or margins coupled with the rise in food and fuel costs really puts restaurants in a very difficult positon....especially those that have to actually operate the restaurant.

Maybe we should bail out restaurants just like we did Wall Street?

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#4) On January 24, 2011 at 12:33 PM, truthisntstupid (93.32) wrote:

If increased food prices would slow them down, it sure would make my job a lot easier.  I'm a cook.  Unfortunately (or fortunately) people have been eating out more...and more...and more..for years now.  Last summer was the busiest one we've ever had.  And our regular customers know food prices are going up.   They'll still come.  Boy oh boy my job is secure. 

Share prices for stocks like Darden may go down because people that don't realize how busy many restaurants are worry about food prices.  These businesses may struggle for a short time, but they certainly will still be there ten years from now.  Price drops represent a buying opportunity for stocks like Darden, Sysco, etc.

 

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#5) On January 24, 2011 at 12:38 PM, lorteungen (99.76) wrote:

The price on Brent could have something to do with this: http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/8270272/US-trader-Hetco-drives-up-oil-price.html

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#6) On January 24, 2011 at 12:45 PM, Valyooo (99.48) wrote:

I dont get why this would be a problem.  Food goes up for every restaurant, they all raise prices, consumers are forced to pay more.  Same margins, higher nominal price.  Whats the diff?

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#7) On January 24, 2011 at 1:17 PM, alstry (36.57) wrote:

Here is why it is a problem....

Food prices go up......more money is spent on food and less on everything else

Since most people in America work in everything else....wages go down and fewer can afford to eat and do anything else at the same time

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#8) On January 24, 2011 at 1:21 PM, truthisntstupid (93.32) wrote:

It is not a problem...get a job in a busy restaurant and do 15 hours without ever sitting down and never leaving the line. 

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#9) On January 24, 2011 at 1:29 PM, blueberrygoo (74.44) wrote:

#6 the problem is that this is much like the explanation of our current core CPI and a "basket of goods".  If the price of McD's goes up, then people see that and decide to drive past McD's and go eat at Taco Bell.  Sure Taco Bell's prices went up too, but the consumer was paying $5 for a happy meal, and now wants to only spend that same $5.  Taco Bell sees this and comes up with a colon blowing $5 value meal and takes away customer base.

So what happens is yes, McD's margins as a % are the same if they adjust their prices upwards.  However if consumer sentiment changes as I've shown in the example above, then McD's overall sales revenues will decrease and therefore the bottom line, profit, is reduced.  

 

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#10) On January 24, 2011 at 1:36 PM, truthisntstupid (93.32) wrote:

I'm not the least bit worried and my livelihood is at stake.

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#11) On January 24, 2011 at 3:42 PM, leohaas (31.28) wrote:

I think the answer is right in Deej's fine post:

The company said its "grocery bill" -- what it pays for the 10 different commodities that account for around 75 percent of its food preparation costs -- is expected to rise this year 2 percent to 2.5 percent in the United States and 3.5 percent to 4.5 percent in Europe.

So, if MCD decides to increase its prices accordingly, a big mac will go form $3.73 to about $3.81 in the US, and from $4.60 to about $4.78 in the Euro zone. I don't think that will lower the number of big macs sold, but I may be wrong of course...

Unless the economy makes a major dip or collapses like some here on CAPS predict, the impact will be very low on MCD and its competitors. FWIW: I believe YUM has a better potential in this arena because so far it has been better at expanding in Asia.

 

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#12) On January 24, 2011 at 4:10 PM, tekennedy (79.33) wrote:

Foodservice went from being 50% of food purchases (as opposed to grocery) to roughly 47% market share as a result of the recession. If inflation stays high consumers could continue this trend to save money. I expect both margin pressure and volume declines for most restaurants, although these effects will likely be temporary.

If you want to read more into this I just posted today a writeup for Sysco which goes into this a bit titled "Assistance from the CAPS Community (part II)". Sysco provides a good window into the restaurant industry as the largest distributor.

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#13) On January 24, 2011 at 4:38 PM, Valyooo (99.48) wrote:

Blueberrygoo,

If food prices go up, then taco bell wouldnt be able to afford the $5 meal.  If they could, McDonalds would be able to as well.  These are called "menu costs", one of the few non-distributive costs of inflation (the other main one being shoe leather cost)

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#14) On January 24, 2011 at 7:04 PM, truthisntstupid (93.32) wrote:

Dig up all the numbers and statistics you want.  Nobody was listening last summer, either.  Feet on the ground could provide people with insights that won't show up in your statistics until much later.  

I commented on many posts last summer, posts in which the poster was speculating on whether the economy wasn't possibly better than many people thought.

Last summer I had a heat stroke working from 5AM till 9PM with no time to take breaks.  I'm not exaggerating.  No breaks means not one minute that I could slow down.  Between tickets to be cooked, normal everyday prep, and prep for the special I wanted to run that night, there was never a minute and I forgot to eat...even though I'm always surrounded by food.

 Last summer was our busiest we've ever had.  There are better investments than restaurants right now, but they sure aren't going anywhere.  I haven't looked at Sysco for a while, but they dominate, and I mean DOMINATE their place in this industry.  I sure wouldn't sell if I owned shares, that's for sure.

They have raised their dividend for the 34th straight year now..  Their quarterly dividend is 26 cents/share now...3.71X what it was 10 years ago.  The quarterly dividend paid 1/03/2001 was 7 cents/share.

The only reason I have never owned Sysco is because up until recently I have used only direct stock purchase plans for my  investing, and they didn't have a DSPP.

I'm not using DSPPs any more, and if I'm considering opening a Sharebuilder account now.  If I do, SYY looks very good.  

I won't link to my July 27, 2010 pitch, because the editor takes an otherwise good pitch, mashes it all together, and makes it an eyesore to try and read.  Very little has changed since then, except interest coverage has gone from 15.3 to 16.2.

 I can't speak for other areas of the country.  That's true.  But if any industry is recession-resistant, this is it.  

 

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#15) On January 24, 2011 at 9:36 PM, tekennedy (79.33) wrote:

I agree SYY is a good investment, I've been long it on CAPs and have owned it in real life.  I wasn't attempting to be generally bearish, just trying to throw in some relevant info.  Having a front row seat is helpful but it shouldn't make you ignore other relevant information.  There are successes and failures everywhere.  I'm not foretelling the doom of restaurants here, just saying the average restaurant could have a tough road ahead because of high inflation and a tough fight for customers. 

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