Industry reports improvement, but rising fuel and commodity costs threaten progress

Industry reports improvement, but rising fuel and commodity costs threaten progress

As restaurant operators from across the country descend on Chicago for the 2011 National Restaurant Association Restaurant, Hotel-Motel Show, they are buoyed by a tenuous optimism that many acknowledge could evaporate at any moment.

Some signs are mounting that the economic recovery is moving forward, with nonfarm jobs trending up by 216,000 in March, even as the unemployment rate remained unchanged at 8.8 percent. And anecdotal evidence is growing, too, with many operators saying that sales are on the rise. 

Still, the momentum remains frustratingly slow, with higher commodity costs and escalating gas prices threatening to extinguish the economy’s fragile progress.

In April The NPD Group reported in conjunction with Morgan Stanley that customer traffic levels, which had plummeted in 2008 and 2009, had rebounded to 2005 levels in 2010, with families making a notable return to restaurants and deals still accounting for 25 percent of all restaurant visits. 

“Nobody should assume growth is going to come back at a quick rate in 2011 or 2012,” said
Warren Solochek, NPD’s vice president of client development, during a webinar on the recovery. “It’s all a share game. I would have said at the end of 2010 that we’d be less dependent on value, but gas and grocery prices have gone up, so we all have less to spend.”

He noted, however, that product innovation and unit redesigns would be helpful in luring cost-conscious consumers back to restaurant dining rooms and weaning them from widespread discounting going forward.

“People always want new, and they’re always willing to try new,” he said.

In March the NRA reported that gains in same-store sales and customer traffic helped to boost its most recent Restaurant Performance Index, or RPI, for February to 100.7, marking the fifth time in the past six months that the index passed 100.

The RPI, which is based on responses to a nationwide survey on such topics as sales, traffic, labor and capital expenditures, tracks the health and outlook for the restaurant industry.

The February index reflected operator optimism surrounding capital spending, employment, and same-store sales and traffic gains. Forty-nine percent of respondents reported a same-store sales gain between February 2010 and February 2011, up from 39 percent of operators who reported higher same-store sales in January. In comparison, 37 percent of operators reported a same-store sales decline in February, down from 44 percent of operators who reported lower sales in January.

Restaurant operators also reported a net increase in customer traffic levels in February. Forty-one percent said traffic between February 2010 and February 2011 was up, compared with 35 percent of operators who reported higher traffic in January. In comparison, 39 percent of operators reported a traffic decline in February, down from 44 percent in January.

“In fact, February was a record-high sales volume month for the restaurant industry,” said Hudson Riehle, senior vice president of the NRA’s Research and Knowledge Group, who quickly acknowledged that the good news is tempered.

“However, there are challenges on the operator horizon that require monitoring by both the operators and consumers,” he said, pointing to both rising gas and wholesale food prices, which could eat into consumers’ cash on hand.

That uncertainty left some operators feeling less than great about the general economy, with only 34 percent saying they expected conditions to improve in six months, down from 42 percent in January. Meanwhile, 14 percent said they expected economic conditions to deteriorate.

Gas-price pressures

Most prominent among these challenges are gas prices, which have risen steadily over the past month, conspiring to dull already anemic consumer enthusiasm for spending.

As of April 22, the national average for a gallon of gas was $3.84, up from $3.55 a month earlier and nearly $2.86 a year earlier — a 34-percent hike — according to AAA. While this remains below the $4.11-per-gallon high hit July 17, 2008, some operators are girding for the worst.

Among them are Ruby Tuesday, the 900-unit casual-dining chain based in Maryville, Tenn. The company, which reported a 10-percent drop in net income to $16 million for the third quarter ended March 1, pointed to particularly bad winter weather in its core northern markets and expressed concern over the potential impact of rising gas prices. 

“We have seen sales in [the bar and grill category] lag casual dining overall, and have recently seen some non-weather-related issues in some of our markets, moreso in the South, which is most likely due to the gas prices being significantly higher year-over-year, and tracking a bit like we saw in 2008,” said Samuel “Sandy” Beall, Ruby Tuesday’s chairman and chief executive, during an April 6 conference call with analysts.

Revenue for the quarter rose 3.8 percent to $319 million, partly on the acquisition of some franchised units, officials said. Meanwhile, same-store sales at the chain’s domestic corporate units fell 1.2 percent, while those at domestic franchised units rose 0.4 percent. 

“Our sense is that the economy is softer than it was in the fall and that consumers are adjusting spending behavior,” Beall continued. “We are actively responding with sales-building programs to drive traffic in these markets, which we hope will offset this behavior over time.”

Consumer outlook

Many consumers also are expressing concern. After advancing in February to 72.0, the Consumer Confidence Index retreated to 63.4 in March, reflecting a less-favorable short-term outlook for business conditions, according to the Conference Board. The so-called Expectations Index fell dramatically from 97.5 in February to 81.1 in March. The indexes are calculated from responses by a random sample of consumers.

Between February and March, the number of consumers claiming business conditions were “good” increased to 15.1 percent from 12.4 percent, and those claiming business conditions were “bad” decreased to 37.0 percent from 39.3 percent. At the same time, consumers’ appraisal of the job market fell, with those saying jobs are “hard to get” edging up from 44.4 percent to 44.6 percent, while those stating jobs are “plentiful” dipped from 4.9 percent to 4.4 percent.

“The sharp decline in confidence was prompted by a sharp decline in expectations,” said Lynn Franco, director of The Conference Board Consumer Research Center. “Consumers’ inflation expectations rose significantly in March, and their income expectations soured, a combination that will likely impact spending decisions.”

On the other hand, she said, “Consumers’ assessment of current conditions improved, indicating that while the short-term future may be uncertain, the economy continues to

Consumers’ worries about inflation were not misplaced, as the Consumer Price Index increased a seasonally adjusted 0.5 percent in March, according to the U.S. Bureau of Labor Statistics. Hikes in gasoline and food prices accounted for almost three-quarters of the increase, the agency said.

The effects of higher gas and food prices also played out in the monthly Thomson Reuters/University of Michigan consumer sentiment index released in March, with respondents also voicing concerns about their immediate futures. Only 25 percent of respondents said they expected their financial positions to improve in the year ahead, and the percentage who said they expected the economy to improve in the year ahead dropped from 41 percent in February to 21 percent in March — the largest one-month decline ever recorded in the survey’s history.

“The proximate cause of the sharp drop in confidence was the rise in gas and food
prices,” said Richard Curtin, the survey’s chief economist. “The more damaging cause, however, was that the fewest consumers in more than a half century expected income increases, and many fewer anticipated gains in their inflation-adjusted incomes.”

He noted that a decrease in the unemployment rate would help to spur both consumer confidence and spending.

“The data clearly indicate that the rate of real consumer spending will diminish, but the data do not indicate a renewed downturn is now on the horizon,” he said. “Continued job gains are essential, as even modest job losses could quickly shift consumers toward retrenchment. For now, consumers find discounts attractive and remain willing to modestly increase their spending.”

Which is why Darden Restaurants Inc. will keep an eye on its value proposition — even as rising costs force it to take price increases on certain items. The Orlando, Fla.-based parent of such casual-dining chains as Red Lobster, LongHorn Steakhouse and Olive Garden said value-oriented promotions played a big role in pushing blended same-store sales up 0.9 percent in the most recent third quarter.

During a conference call with analysts in late March, company officials said that price increases of 2 percent to 3 percent would be applied only to items that could withstand such hikes, even as judicious value promotions remain crucial to Darden’s strategy.

“Value has to be part of the mix as you think throughout the year,” said Drew Madsen, Darden’s president and chief operating officer. “But it’s not a continuous siren song around price points and promotion.”

Read more: See a slideshow of what operators around the country had to say about 2011 [3]

Contact Robin Lee Allen at [email protected] [4].