Get Ready for Higher Restaurant Prices

Restaurants are poised to raise prices as Americans become accustomed to more expensive food at grocery stores.

U.S. consumers paid 2.6 percent more at eateries in September than last year, while food prices at supermarkets were 6.2 percent higher, according to the Bureau of Labor Statistics’ monthly consumer-price index. Inflation for eating at home has accelerated faster than dining out during the past year, reaching its widest gap since 1990 last month.

Restaurants monitor this differential because they don’t want to appear too aggressive with menu pricing relative to the cost of food at home, said Jeffrey Bernstein, an analyst with Barclays Capital in New York. This gives companies “more credibility” in adjusting prices, particularly as commodity inflation puts pressure on margins, he said.

“If people go to the supermarket and see that the core items they’re purchasing are on the rise, then they are less likely to be surprised if restaurants are raising prices as well,” Bernstein said.

The Standard & Poor’s Supercomposite Restaurants Index, which includes McDonald’s Corp. (MCD) and Chipotle Mexican Grill Inc. (CMG), has gained 58 percent since Dec. 31, 2009, while the S&P 500 has risen 15 percent, Bloomberg data show. Further outperformance is likely, partly because restaurants have been able to raise prices “despite difficult economic conditions,” said Rick Campagna, chief executive officer of 300 North Capital LLC, who manages $500 million at the Pasadena, California-based investment firm.

Faster Inflation

Faster inflation for food at home compared with food away from home “might allow for additional pricing actions” at McDonald’s, Chief Financial Officer Peter Bensen said on an Oct. 21 conference call. This would help the company offset commodity costs that rose 8 percent in the three-month period ended Sept. 30, he said.

The world’s largest chain likely has the most influence over the industry, and particularly fast-food, when -- and by how much -- it adjusts prices, Bernstein said. It has changed U.S. menus twice so far this year: a 1 percent bump in March followed by 1.4 percent in May, Bensen said. Domestic sales grew 4.4 percent in the third quarter, the Oak Brook, Illinois-based company reported.

Food prices rose at an 8 percent annual pace in September, according to the Bureau of Labor Statistics’ producer-price data. Commodity costs account for a much larger share of expenses at supermarkets than at eateries, so there’s been a “delayed pass-through” as restaurants absorbed some of the increases, said Dean Maki, chief U.S. economist at Barclays Capital in New York.

Income Growth

Following the lead of supermarkets, restaurants have some confidence consumers can afford to pay more because of moderate growth in employment and income, Maki said. Employers added 103,000 workers in September, the Labor Department reported, more than forecast. Personal income rose at an annual rate of 4.4 percent in September, marking 21 months of yearly growth, Bureau of Economic Analysis data show.

Companies may take creative approaches to effectively raise prices, such as reducing promotions, offering higher-end specials or emphasizing certain menu items, said Todd Hooper, a San Francisco-based restaurant strategist at consulting company Kurt Salmon.

Eateries need to “think very deliberately” about making adjustments to avoid driving away their core base of diners, he said. “They can’t be too aggressive.”

‘Better Value’

Fast-food chains may have more success because their prices are closer to food-at-home than full-service restaurants, said Sara Senatore, an analyst at Sanford C. Bernstein & Co. in New York. Given the opportunity cost for employed Americans to prepare meals at home, it “might be a better value” to eat out, she said.

BJ’s Restaurants Inc. (BJRI) in Huntington Beach, California, deferred until November increases it typically would have taken in May, Chief Executive Officer Gerald Deitchle said on an Oct. 21 conference call. Prices are “slightly lagging our cost pressures, and we plan to prudently deploy some additional menu pricing with the rollout of our fall menu update,” he said.

Price increases at Chipotle of about 3.5 percent in the quarter ended Sept. 30 weren’t met with “any noticeable resistance,” Chief Financial Officer John Hartung said on an Oct. 20 conference call. While the Denver-based company “had room” to make bigger adjustments, it was “a fair price increase” and Chipotle doesn’t plan further changes, he said.

‘Big Bang’

For budget-conscious consumers, the “big bang for the buck” still is eating at home, even if it also costs more, said Bill Lapp, president of Advanced Economic Solutions, an Omaha, Nebraska-based research company. The tradeoff is driven much more by unemployment than any price spread, he said.

The jobless rate, at 9.1 percent in September, has been above 9 percent for 27 of the past 29 months, Labor Department data show. Meanwhile, confidence as measured by the Bloomberg Consumer Comfort Index declined in the week ended Oct. 23 to the lowest level in a month.

Grocery stores are having more success in passing along rising food costs because they have less excess supply than dining establishments, Lapp said. “There’s more capacity than restaurants have demand,” which means only some will successfully raise prices.

‘More Confidence’

Strong sales at Buffalo Wild Wings Inc. (BWLD) and Texas Roadhouse Inc. (TXRH) -- up 5.7 percent and 4.4 percent at company-owned restaurants in their most-recent quarters -- should give these chains “more confidence” in making price adjustments to offset commodity-cost inflation, said Bernstein of Barclays, who maintains “outperform” ratings on these stocks and McDonald’s.

System-wide sales at Panera Bread Co. (PNRA) rose 4.4 percent in the 13 weeks ended Sept. 27, the St. Louis-based company said Oct. 25. Panera raised prices by about 2.5 percent and plans another increase of 3.5 percent in the fourth quarter, Chief Executive Officer William W. Moreton said on an Oct. 26 conference call.

Panera and Chipotle are among the restaurants 300 North Capital holds because of the “great earnings results” their price increases helped to generate, Campagna said. The industry is more resilient because it remains an affordable splurge for consumers in a “tough economy.”

“People are doing smaller things for entertainment, such as eating out as opposed to taking a vacation,” he said. “Investors are looking for consumer discretionary sectors, like restaurants, where the competitive position is improving.”

To contact the reporter on this story: Anna-Louise Jackson in New York at ajackson36@bloomberg.net

To contact the editor responsible for this story: Anthony Feld at afeld2@bloomberg.net

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