On the Margin

Low commodity costs are both blessing and curse

This post is part of the On the Margin blog.

This year, restaurants are thankful for low commodity costs. After a couple of years of dealing with rising costs of beef and other proteins, the low commodity price environment has been a blessing — more than offsetting rising labor costs.

But as good as they’ve been for profits, low commodity costs have had a big downside.

Cracker Barrel Old Country Store Inc., for instance, said Tuesday that food and other restaurant costs fell 210 basis points in the first quarter, to 25.4 percent of sales, from 27.5 percent of sales the previous year. Commodity costs fell 5.1 percent in the quarter — an unexpectedly large decline.

While labor costs increased modestly, Cracker Barrel still enjoyed a more profitable quarter thanks to lower commodity costs. Net income increased 18 percent, beating expectations and thrilling Wall Street.

But Cracker Barrel reported something else: A traffic decline of 1.7 percent.

As we’ve been writing about for some time now, the pricing gap between restaurants and grocery stores has been widening all year. The same low commodity prices helping the restaurant industry are also enabling grocers to lower their prices.

While that hasn’t necessarily been great for supermarkets, there’s plenty of evidence to suggest that the pricing gap is the primary reason restaurants have seen sales decline for much of the year.

Andrew Strelzik, an analyst with BMO Capital Markets, said at the Restaurant Finance and Development Conference last week that commodity deflation historically leads to same-store sales weakness. And when costs increase, same-store sales follow suit.

“As commodity prices are more inflationary, restaurant sales trends get stronger nine months later,” he said. “As food costs [fall], sales slow nine months later.”

It’s not just sales, he said. Traffic moves in the same direction.

Weakness in restaurant sales this year has been entirely due to weak traffic. Restaurants have raised prices, worried about labor costs, and often hiding the lost customers in the process.

Many restaurant executives understand that they lack pricing power in this environment. Cracker Barrel this week also said it would be conservative on sales projections for the year because of traffic weakness, but also because the company plans to hold the line on pricing.

“We remain careful in this environment,” Cracker Barrel CEO Sandy Cochran said during an earnings call Tuesday.

Jonathan Maze, Nation’s Restaurant News senior financial editor, does not directly own stock or interest in a restaurant company.

Contact Jonathan Maze at [email protected]
Follow him on Twitter: @jonathanmaze

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