Food Costs Sour Investors on Restaurant Stocks

We're caught in the middle of a food fight, and it's not pretty. Drought in California has already pushed avocado prices up 40 percent this year. Now researchers at Arizona State University estimate significant impact on a number of other fruits and vegetables as well.

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Tea-maker turned organic juggernaut Hain Celestial Group, Inc. (HAIN ) has become Whole Foods Markets, Inc.'s (WFM ) top supplier. Hain founder and Chief Executive Officer Irwin Simon explained to us this morning on Surveillance he can't "pass along a 40 percent rise in almonds used to make almond butter." So he's having to get more creative in order to preserve margins and still grow sales.

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Some food companies are better than others at dealing with wholesale inflation. We netted sales growth against earnings growth as a proxy for profit margins and discovered restaurants are significantly more impacted than producers when costs rise. As Irwin explained this morning, restaurants are closer to consumers and have few levers to pull, like sourcing and substitution. Hence, they have a more challenged profit outlook. (Chipotle Mexican Grill has announced it may discontinue offering avocados at many of its restaurants.) Consider these six examples from the 70 food-related companies in the S&P 1500 Index:

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Comparing stock performance of restaurants and food producers, investors have clearly figured out the difference. Producers are up, restaurants are down. Given projections from ASU, and Mr. Irwin's commentary this morning, we're inclined to avoid restaurants near-term.

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