The restaurant industry is in the best shape it’s been in since the recession hit in 2008. Sales are good for most concepts. Gas prices are low. Balance sheets look strong. Many chains that had held back on unit growth are building new locations. Valuations are at levels heretofore unseen in the eatery business.
And yet, something appears to be holding the industry back from the growth it has traditionally experienced over the three largely unchecked decades before the U.S. financial crisis.
In relative terms, the industry’s aggregate sales growth will be moderate, at best, particularly after adjusting for inflation.
Perhaps more important, overall traffic growth will remain stagnant, with periods of positivity and negativity fluctuating up or down 1 percent to 2 percent, according to many predictions.
With that new reality, the restaurant industry is largely a game of market share. Consumers aren’t eating out significantly more often, even now that they have additional discretionary income, improved confidence and more jobs. And with unit saturation in the U.S., restaurants will have to take business from others — and that’s not easy.
“It’s definitely the new normal,” said Darren Tristano, executive vice president for industry market research firm Technomic Inc. “The periods of very fast growth we saw pre-recession likely led us into a bubble. Now I think we’re seeing more moderate growth.”
Technomic expects about 5 percent industry sales growth this year, which when adjusted for inflation, is about 2 percent in pure terms.
The high tide
Industrywide same-store sales rose 2.8 percent in the first quarter of this year, according to sales tracker Black Box Intelligence, a division of research firm TDn2K. That was the best quarterly performance in the post-recession era, according to the research firm. That number included a 6.1-percent same-store sales increase in January, the only month unencumbered by bad weather in any major part of the country. Black Box tracks performance from more than 110 restaurant brands and over 20,000 restaurant units.
The economy is also growing at a steady rate. Gas prices, in particular, are more than $1 per gallon lower than they were at this time last year, a price decrease that puts $60 in cash in the hands of a driver who uses 60 gallons a month. That amount is particularly welcome to lower- and middle-income consumers who have held back most on restaurant spending since the recession.
“If I’m a consumer, I feel better,” said Brad Swanson, managing director of investment banking for KeyBanc Capital Markets. “I’m paying debt with half of my gas savings, the other half on restaurants, or clothing. So there’s maybe not 100 percent trickle down, but 50 to 75 percent.”
Indeed, consumers are more confident. Consumer Confidence rose in March as consumers’ outlook for business conditions and the labor market improved. Unemployment, meanwhile, has fallen to pre-recession levels. Those two numbers matter a great deal to a restaurant business that relies on confident consumers with jobs.
“With lower unemployment and a much improved economic outlook, this should be a very good year for all segments in the restaurant space,” said Ralph Bower, CEO of Pei Wei Asian Diner.
And restaurant businesses themselves are in rock solid shape. Balance sheets have improved as companies paid down debt and solidified their financials. According to research firm AlixPartners, distress levels among restaurant companies are at historic lows and relatively few companies are at risk of bankruptcy.
“To some degree, it’s a testament to the great recession,” said Adam Werner, managing director at AlixPartners. “Folks spent time holding back dry powder to make sure they didn’t have liquidity concerns. They’ve got some cash. They’ve got stronger balance sheets. Now they’re thinking about growth.”
Indeed, more chains are beginning to expand. Popeyes Louisiana Kitchen Inc., for instance, opened more locations than in any year on record in 2014. Domino’s Pizza Inc., meanwhile, also started adding locations in 2014 after years of strong same-store sales but almost non-existent unit growth.
Restaurants are also adding jobs. More than 150,000 jobs were added in the foodservice sector between December 2014 and February of this year, according to federal data. That’s the largest three-month period for job growth in industry history, according to the National Restaurant Association.
And there’s more. Sales growth and the industry’s overall improvement have given restaurant companies extraordinary valuations on Wall Street. Some of the hottest initial public offerings in recent years have involved fast-casual restaurant chains like Shake Shack Inc., and Habit Restaurants Inc. Even El Pollo Loco Holdings Inc., a company that was perilously close to bankruptcy coming out of the recession, saw its stock price more than double in the days following its IPO last year.
Valuations are so high, in fact, that the industry is attracting investors who might not have even thought of the industry just six months ago.
Take the story of Nexus Energy Services, a mid-level provider of oil pipeline and other services in the South. It’s a small company, publicly traded over the counter. In April, Nexus Energy Services got out of the oil business and merged with a two-unit fast-casual burger chain out of Denver called Illegal Burger.
The reason? Oil prices have fallen in half; fast-casual burgers are hot. “Due to the recent downturn in oil prices, the company will cease oil and gas operations and is pleased to move into the restaurant sector,” Nexus said in a statement.
The low tide
And yet, for all of these advantages, actual traffic growth — the true indicator of restaurant industry demand — remains a difficult goal for the industry to attain. Go back to that first-quarter Black Box Intelligence number. Traffic actually fell in the first quarter, by 0.6 percent, despite very good quarterly sales trends.
“There’s been no growth in terms of traffic,” said Bonnie Riggs, restaurant industry analyst for market research firm The NPD Group, which expects that traffic growth will average less than 0.5 percent a year through 2022.
There is plenty of movement within that stagnant traffic. Consumers are shifting from full-service restaurants to quick service, and they’re opting to eat at fast-casual restaurants or get food from grocery stores and convenience stores, each of which have improved food offerings.
Consumers made 61 billion visits to restaurants in February, Riggs said, and 22 percent of those visits were to full-service restaurants. That percentage has been declining since the end of the recession, though there was a bit of an increase at the end of 2014 — again, attributed to lower gas prices.
The balance of visits has gone to limited-service brands, Riggs said — but with traditional quick-service restaurant chains losing share to fast-casual restaurants. While shifts are favoring this format and style, fast-casual restaurants still represent just 5 percent of total industry traffic.
Consumers have also been opting for retail food outlets, including grocery store delis and convenience stores.
“Competition for many restaurant operators is no longer just the other fast-food restaurant down the road,” Riggs said. “It’s fast casual. It’s food retailers. It’s c-stores. And the biggest one is the home. [Consumers] have gotten used to being home.”
For decades, the industry grew because more women were entering the workforce, and dual-income households dine out more often. In 1999, the percentage of women in the workforce peaked at 60 percent, according to federal data. By 2012, that percentage fell to 57.7 percent.
“We have fewer women entering the labor force,” Riggs said. “That is a negative. There was strong growth throughout the 1980s and 1990s that supported the [restaurant] industry. Now it’s turned negative. We no longer have that support.”
Another challenge for restaurant traffic is the shrinking middle class. Having fewer middle class consumers hurts casual- and family-dining chains in particular, and means that fewer consumers in general have money to eat out more often.
Even with the unemployment rate shrinking, wage growth has been almost non-existent. This has hit younger, Millennial consumers hardest. Just like the dining at home trend is supported by fewer women in the workforce, Millennials are also staying at home. “They’ve gotten used to being at home,” Riggs said. “A lot are cooking. They like it. Many say they love it.”
On top of it all, there is some initial evidence that consumers are shifting attitudes away from traditional restaurant chains and toward newer concepts that offer more healthful, freshly prepared items with freshly sourced ingredients.
Consider that growth for four of the biggest chains in the country has been either flat — Wendy’s and Burger King — or down, like the 1.1 percent decline in same-store sales at McDonald’s in 2014, or the 3 percent drop at Subway, according to Technomic.
“When four of the top five brands continue to struggle, it’s hard to get optimistic about the growth rate of the industry,” Technomic’s Tristano said. Smaller brands and independent restaurants can be “more nimble” and can respond to trends much faster, he said, and that may drive the industry forward.
“While all these bigger chains are struggling to keep up and catch up, the smaller chains are able to add items that consumers are looking for,” he added.
There are clearly conflicting themes. The industry sees a rising tide of aggregate data and improved macro-economic trends helping drive the industry, especially in the first quarter, but also a receding tide of continued pressure on guest traffic and certain demographic trends leading to less dining out.
Restaurants can succeed in the market by keeping their brand promises to the consumer, providing a good value for the money, fresh ingredients and good service. Meeting or exceeding those expectations can build loyalty and keep customer business in the face of heavy competition.
“We’re still dealing with a very cautious and controlled spender,” Riggs said. “When they go out, they expect to get what they pay for. If you don’t meet those expectations, they’re not going to come back.”
Contact Jonathan Maze at [email protected]
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