On the Margin
restaurant check

Moody’s turns more bearish on restaurants

This post is part of the On the Margin blog.

Rising labor costs and higher non-discretionary spending are both conspiring to eat into restaurant industry sales.

So says Moody’s Investors Service, which this week downgraded its outlook on the restaurant industry, to “Stable” from “Positive.”

The ratings agency expects slower operating income growth in the industry of 2 percent to 4 percent — down from its previous call of 5 percent to 6 percent.

“Consumers are wrestling with higher non-discretionary spending needs,” Moody’s analyst William Fahy said in a statement, “while restaurant companies face higher operating costs, predominantly labor and challenged traffic trends.”

Traffic is the biggest problem facing the industry at this point. Fewer customers are dining out at restaurants, based on both the Black Box Intelligence and MillerPulse industry surveys. Moody’s suggests that higher costs in other elements have reduced consumer discretionary spending.

Health insurance costs, for instance, have been increasing at a rapid clip. Housing costs are up. Consumers have been buying new cars. Gas prices also ticked up. All that takes away from the discretionary spending restaurants rely on for their sales.

While commodity costs are falling this year, labor costs are expected to increase. Rising minimum wages, competition for labor in a low-unemployment environment and other costs such as those expected from new overtime rules could all play a role in lowering profits.

restaurant check
According to both the Black Box Intelligence and MillerPulse industry surveys, fewer customers are dining out at restaurants. Photo: Photobuff/istock/Thinkstock

And yet the industry is stuck, Moody’s says. Operators “will be hard-pressed to raise prices without hurting traffic.”

More ominous: These labor costs will become an even greater concern once commodity prices rise again, Moody’s notes.

Restaurants having limited pricing power in this environment. Remember, the industry aggressively increased prices in recent years to meet rising commodity costs. They don’t have that ability, especially as grocers are aggressively lowering prices.

Moody’s expects that the use of promotions in the industry will remain high, “limiting earnings potential at a time when commodity costs are low.” Not surprisingly, the agency expects casual dining will be most challenged, while fast-casual restaurants will outperform the industry and traditional quick-service restaurants find the industry difficult given uncertainty.

That said, the challenges wouldn’t be broad based. There will be winners and losers, and Moody’s expects the gap in performance between the two will grow.

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 at @jonathanmaze

TAGS: Sales Trends
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