Forecast: Higher spending may ease margin squeeze

Forecast: Higher spending may ease margin squeeze

Cautious optimism is the prevailing sentiment restaurant industry insiders express as they look toward business in 2007—a year of anticipated top-line growth with no shortage of negative pressures on profit.

While economic indicators point to increasing consumer confidence and rates of disposable income—two key statistics that directly relate to restaurant sales—escalating operating expenses, including inflated minimum-wage rates, higher commodity costs, increased competition for real estate and higher construction expenses, are expected to take major bites out of margins.

“The backdrop for 2007 is that it should be equal to or better than 2006,” says Robert Donnelly, head of restaurant sector investment banking at Raymond James & Associates in St. Petersburg, Fla. “The more reasonable fuel prices and low unemployment rate puts everyone in good shape for the first half [of the year] at least. The consumer is set up better than they were in 2006.”

According to the University of Michigan’s latest survey of consumers, for November, inflation-adjusted personal consumption expenditures should advance at a 3-percent rate of growth during the year ahead.

“The strength in consumption spending will propel the economy forward at a 2.5-percent growth rate in [gross domestic product] during 2007—a slower but still positive pace of growth,” says Richard T. Curtin, director of the survey.

Upbeat spending forecast may ease operators’ margin pressures

The U.S. GDP grew at a rate of about 3.3 percent in 2006 and about 3.2 percent in 2005.

Anticipated improvements in consumer spending are expected to help the restaurant industry post sales gains in the year ahead, according to the National Restaurant Association. The Washington, D.C.-based NRA predicts a 5-percent increase in aggregate food-and-drink sales from 2006, or a 2.1-percent real growth rate when factoring out commodity-related menu price inflation, which the association pegs at 2.9 percent for the year ahead.

The real growth rate for 2007 trumps the real growth rate the NRA estimates for 2006 over 2005, which stands at 1.8 percent.

Sales for the nation’s 935,000 foodservice locations are expected to total nearly $537 billion in 2007, the NRA predicts.

Helping to drive sales growth is a forecasted 3.3-percent increase in inflation-adjusted real disposable income, strong employment rates, and lower and more consistent gas prices versus the record per-gallon highs and volatile price spikes consumers and restaurant operators had to deal with throughout much of 2006, the NRA said.

“When you look at the basic overall economic fundamentals that the industry will operate against, you see an environment that indicates that growth will be equal to, and in some segments stronger than, 2006,” says Hudson Riehle, senior vice president of research and information services for the NRA.

The association also is projecting a real growth rate of 2.1 percent for both the full-service and quick-service sectors.

While that outlook is bullish, according to some observers, it is not altogether unrealistic as major restaurant companies like Yum! Brands Inc. and Darden Restaurants Inc. report they will continue building new units to spark additional sales in 2007, and they also predict annual same-store sales increases of between 2 percent and 4 percent over year-earlier figures.

“Intuitively, traffic will definitely increase next year, as you have population growth and the continual shifting of portions of the food dollar to away-from-home spending,” Riehle says. “Real growth comes from different sources, not just one single source.”

Indeed, despite the casual-dining sector’s lackluster performance in 2006, when same-store sales remained negative month after month at bellwether chains like Applebee’s and Chili’s, total corporate revenues continued to improve through new unit development and, at some chains, higher check averages from increased menu prices.

“The reason why sales growth is so important is because in this business we have a lot of fixed and semifixed costs, and those costs are inflating every year,” says Andrew Madsen, Darden’s president and chief operating officer. “We cannot simply price through [to the customer] to cover those costs.”

Covering escalating costs is a major concern for operators, who note that competition and consumers’ frugal habits mean menu prices cannot increase at an unregulated pace. Nonetheless, many restaurant operators are saying they will boost menu prices in 2007, beginning as early as this month, to start to combat increased costs.

Depending on where a company’s restaurants are located, cost pressures this year also will include increased minimum wages or the elimination of the tip credit.

Real estate issues like higher costs for land and building also are top of mind. In addition, operators cite increased competition and the ubiquitous concerns surrounding the tight labor supply as well as the difficulties in recruiting and retaining the right employees.

According to the NRA, states in the West and South expect higher-than-average population, employment and disposable income growth rates in 2007, which will help fuel restaurant sales. The five states with the highest rates of projected restaurant sales growth are Nevada, Arizona, Florida, Texas and Idaho, according to the NRA.

Access to large amounts of capital will continue to help restaurant companies grow for at least the first half of 2007, according to Carty Davis, principal at the Cypress Group, a Southern Pines, N.C.-based investment bank and strategic advisory firm to the franchise and multi-unit restaurant industry.

The restaurant industry saw an unprecedented flurry of merger and acquisition, refinancing and debt financing activity in 2006.

“Cautious optimism is the mood, as there are definite pressures out there,” Davis says. “But operators are growing and the level of liquidity is tremendous. We will still see a lot of deals in at least the first six months of 2007.”

Improved consumer environment expected to spark sales growth

2007 Regional Forecast: Regions ranked by total projected sales in 2007
 PROJECTED EATING-PLACE SALES* ($ BILLIONS)
  20072006
1Southeast$99.16$93.65
2Midwest$87.23$83.62
3West$75.08$71.16
4Mid-Atlantic$65.68$62.35
5Southwest$62.62$58.69
6New England$23.15$22.13
2007 Regional Forecast: Regions ranked by percent change in sales from 2006 to 2007
  NOMINAL PERCENT CHANGEREAL** PERCENT CHANGE
1Southwest6.73.8
2Southeast5.93.0
3West5.52.6
4Mid-Atlantic5.32.4
5New England4.61.7
6Midwest4.31.4
*Includes managed services and nonpayroll food-and-drink places
** Real growth rates adjusted for 2.9 percent menu price inflation
SOURCE: NATIONAL RESTAURANT ASSOCIATION/NATION’S RESTAURANT NEWS
Restaurant industry food-and-drink sales projected through 2007
GROUP I - COMMERCIAL REST. SERVICES1 EATING PLACES 2004 EST. F&D SALES ($000)2006 PROJ. F&D SALES ($000)2007 PROJ. F&D SALES ($000)’06-’07 PERCENT CHANGE’06-’07 PERCENT REAL GROWTH CHANGE’04-’07 COMPOUND ANNUAL GROWTH RATE
Full-service restaurants2$156,856,918$172,769,112$181,580,3375.1%2.1%5.0%
Limited-service (fast-food) restaurants3129,520,592142,932,450150,079,0725.02.15.0
Cafeterias, grill-buffets and buffets44,968,1525,223,7145,448,3344.31.43.1
Social caterers4,936,0075,667,0786,069,4407.14.17.1
Snack and nonalcoholic beverage bars15,741,86418,531,69920,162,4888.85.98.6
  TOTAL EATING PLACES$312,023,533$345,124,053$363,339,6715.3%2.3%5.2%
Bars and taverns14,438,49215,302,92415,792,6183.2(0.2)3.0
  TOTAL EATING-AND-DRINKING PLACES$326,462,025$360,426,977 $379,132,28955.2%2.2%5.1%
MANAGED SERVICES6
Manufacturing and industrial plants$6,281,258$6,905,276$7,099,2562.8%(0.1)%4.2%
Commercial and office buildings2,129,8792,334,7742,430,5004.11.24.5
Hospitals and nursing homes3,361,6433,833,7564,065,1776.04.26.5
Colleges and universities8,594,98110,034,08010,897,0118.64.88.2
Primary and secondary schools3,766,0724,602,5175,012,1418.96.210.0
In-transit restaurant services (airlines)2,061,4881,921,4711,948,3721.4(1.6)(1.9)
Recreation and sports centers4,019,6724,368,5554,560,7714.41.44.3
  TOTAL MANAGED SERVICES$30,214,993$34,000,429$36,013,2285.9%2.9%6.0%
LODGING PLACES
Hotel restaurants$22,166,551$25,047,493$26,425,1055.5%2.5%6.0%
Other accommodation restaurants359,827396,774412,2483.91.04.6
  TOTAL LODGING PLACES$22,526,378$25,444,267$26,837,3535.5%2.5%6.0%
Retail-host restaurants721,372,39923,788,29125,053,3485.32.45.4
Recreation and sports810,907,42511,916,36412,626,7436.03.05.0
Mobile caterers866,738951,543980,4893.00.14.2
Vending and nonstore retailers99,402,93210,219,10610,556,3363.31.33.9
  TOTAL - GROUP I$421,752,890$466,746,977$491,199,7865.2%2.3%5.2%
GROUP II - NONCOMMERCIAL RESTAURANT SERVICES10
Employee restaurant services11$623,425$470,160$478,7611.8%(0.1)%(8.4)
Public and parochial elementary, secondary schools5,206,3215,382,6265,362,423(0.4)(3.1)1.0
Colleges and universities5,624,9635,700,7345,718,9530.3(3.5)0.6
Transportation1,459,7671,724,4651,856,4977.75.58.3
Hospitals1211,885,88312,634,18212,962,6712.60.82.9
Nursing homes, homes for the aged, blind, orphans and the mentally and physically disabled136,087,9486,433,9486,581,9292.30.62.6
Clubs, sporting and recreational camps7,594,8858,553,3329,061,2355.92.86.1
Community centers1,579,2021,703,1211,754,2153.01.33.6
  TOTAL - GROUP II$40,062,394$42,602,568$43,776,6842.8%0.3%3.0%
  TOTAL - GROUPS I AND II$461,815,284$509,349,545$534,976,4705.0%2.1%5.0%
GROUP III - MILITARY RESTAURANT SERVICES14
Officers’ and NCO clubs (Open mess)$1,125,810$1,247,121$1,313,2185.3%2.3%5.3%
Military exchanges521,465562,764601,0326.83.94.8
  TOTAL - GROUP III$1,647,275$1,809,885$1,914,2505.8%2.8%5.1%
  GRAND TOTAL$463,462,559$511,159,430$536,890,7205.0%2.1%5.0%
FOOTNOTES
1. Data are given only for establishments with payroll.
2. Waiter/waitress service is provided, and the order is taken while the patron is seated. Patrons pay after they eat.
3. Patrons generally order at a cash register or select items from a food bar and pay before they eat.
4. Formerly commercial cafeterias.
5. Food-and-drink sales for nonpayroll establishments should total $13,770,774,000 in 2007.
6. Also referred to as on-site foodservice and food contractors.
7. Includes drug- and proprietary-store restaurants, general-merchandise-store restaurants, variety-store restaurants, food-store restaurants and grocery-store restaurants (including a portion of delis and all salad bars), gasoline-service-station restaurants and miscellaneous retailers.
8. Includes movies, bowling lanes, recreation and sport centers.
9. Includes sales of hot food, sandwiches, pastries, coffee and other hot beverages.
10. Business, educational, governmental or institutional organizations that operate their own restaurant services.
11. Includes industrial and commercial organizations, seagoing and inland-waterway vessels.
12. Includes voluntary and proprietary hospitals; long term general, tuberculosis, nervous and mental hospitals; and sales or commercial equivalent to employees in state and local short term hospitals and federal hospitals.
13. Sales (commercial equivalent) calculated for nursing homes and homes for the aged only. All others in this grouping do not charge for food served either in cash or in kind.
14. Continental United States only.
SOURCE: NATIONAL RESTAURANT ASSOCIATION
States and the economy: Projected growth rates
All states* ranked by the sum of the percentage changes in total employment, real disposable personal income and total population. Percentages are year-to-year projected growth from 2006 to 2007.
RANKSTATETOTAL EMPLOYMENTREAL DISPOSABLE PERSONAL INCOMETOTAL POPULATION
1Nevada3.1%5.7%2.6%
2Arizona2.7%5.1%2.1%
3Utah1.9%4.9%1.5%
4Florida2.1%4.4%1.7%
5New Mexico2.0%4.3%1.5%
6Texas1.8%4.5%1.4%
7Idaho1.6%4.3%1.4%
8Wyoming2.2%4.2%0.7%
9Washington1.5%3.9%1.6%
10Colorado1.4%4.2%1.3%
11Georgia1.2%3.8%1.7%
12Oregon1.4%3.8%1.4%
13Alabama1.1%3.6%1.4%
14North Carolina1.0%3.4%1.6%
15South Carolina1.3%3.5%1.0%
16Louisiana2.4%3.2%0.0%
17Delaware0.9%3.3%1.4%
18California1.0%3.4%1.1%
19Virginia1.2%3.5%0.8%
20Arkansas1.4%3.4%0.7%
21Minnesota1.3%3.4%0.7%
22Alaska1.0%3.1%1.2%
23Montana1.6%3.3%0.3%
NATIONAL AVERAGE1.0%3.3%0.9%
24New Hampshire0.7%3.4%1.0%
25Tennessee1.0%3.4%0.6%
26Kentucky1.0%3.2%0.8%
27South Dakota1.2%3.2%0.5%
28Hawaii0.7%3.1%0.9%
29Maryland0.7%3.1%0.8%
30Mississippi1.0%3.0%0.4%
31Kansas0.7%3.1%0.6%
32Connecticut0.7%3.2%0.5%
33Illinois0.9%3.1%0.4%
34North Dakota1.0%2.8%0.4%
35Iowa1.0%3.0%0.3%
36Missouri0.8%2.8%0.5%
37Indiana0.7%2.7%0.7%
38Vermont0.6%2.8%0.6%
39Wisconsin0.5%2.9%0.5%
40Massachusetts0.6%3.0%0.3%
41New Jersey0.6%2.6%0.5%
42Nebraska0.6%2.8%0.3%
43Oklahoma0.6%2.8%0.2%
44New York0.7%2.6%0.2%
45Maine0.1%2.6%0.5%
46West Virginia0.4%2.5%0.2%
47Rhode Island0.2%2.6%0.3%
48Ohio0.3%2.6%0.1%
49Pennsylvania0.4%2.2%0.3%
50Michigan0.0%1.7%0.2%
51District of Columbia0.2%0.1%0.3%
*Includes District of Columbia
RANKING: NATION’S RESTAURANT NEWS
SOURCE: NATIONAL RESTAURANT ASSOCIATION