Higher French fry and avocado prices and slower traffic sent shares of Del Taco Restaurants Inc. down more than 18 percent Friday.
The Lake Forest, Calif.-based Mexican chain said late Thursday that its profit margins were lower than expected in the third quarter ended Sept. 12, thanks to higher food costs coupled with already high labor inflation.
On its earnings call, Del Taco executives said that higher prices for avocados, French fries and cheese led to a 40-basis point increase in its food and paper costs as a percent of revenue.
“Based on continued increases in avocado prices” the company expects its food costs to increase 2 percent this year, CFO Steve Brake said on the earnings call. He said avocado prices have “begun to ease down” but are still “elevated.”
Avocados represent only 1.5 percent of the company’s food basket. “It doesn’t sound big, but when it’s priced essentially about double, it can have a significant dollar impact on the year,” Brake said.
Executives also suggested on the earnings call that traffic has weakened so far in the first five weeks of the fourth quarter, amid heavy competition in the quick-service category.
“We have seen a sequential deceleration in both traffic and [menu] mix thus far in Q4 compared to how they performed during the third quarter,” Brake said.
John Cappasola, the chain’s CEO, said that quick-service restaurants have focused more on value in recent months, which is putting pressure on the company’s traffic. “We’re seeing an intensified QSR focus on value right now,” he said, noting the numerous $5 value bundles being offered at many chains, along with low-cost drinks. “That pressure is being put on us a little bit from a traffic perspective.”
The company still expects same-store sales to be positive, he said.
The costs and traffic worries have put a damper on Del Taco’s continued same-store sales strength, and now the company’s stock is down more than 11 percent year to date. Shares closed 18.5% lower, to $12.53 per share, on Friday.
Same-store sales at the 558-unit chain increased 4.1 percent in the quarter, the 16th straight increase. The company in recent years has added more premium items to a menu long known for value. That has generated more traffic from customers seeking higher-priced items.
Labor costs, meanwhile, are rising. As a percent of sales they increased 90 basis points in the period, to 31.6 percent. Brake cited the increase in the California minimum wage to $10.50 an hour, as well as increases to $12 in Los Angeles County and Pasadena.
Brake said the company would take a “holistic approach” to offsetting those higher costs. “It’s not a silver bullet,” he said, noting that menu price “certainly has and will continue to play a role” in its efforts. Traffic, likewise, will help. But higher unit volumes are most important.
Del Taco wants its unit volumes to reach $1.5 million by next year.
“That is our highest priority to overcome costs,” Brake said. But he said the company is “very open-minded” about options to reduce labor costs, including new equipment or food processors or technology.
“It’s definitely something we have been and will remain focused on indefinitely,” he said.
The higher prices mean the company will consider aggressive menu price increases in the future, especially as food inflation creeps in along side labor.
“We have a continued path of wage inflation with the heavy California footprint,” Brake said, adding that there’s another 50-cent increase in the minimum wage there next year.
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