Financial Forecast for Restaurants Remains Weak | Food Newsfeed
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2012 Financial Forecast Remains Cloudy

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Experts say economy, financial conditions are going to look familiar in the New Year.
By Barney Wolf December 2011 Finance

Get ready for more of the same.

Financial analysts, consultants and restaurant operators alike seem to agree that 2012 is shaping up to look a lot like its predecessor year.

The U.S. economy is likely to grow modestly—about 2 percent—with jobs being added at an anemic pace. And, barring any major surprises, commodity prices will move higher, although perhaps not at the same rate as in of 2011.

Dennis Lombardi

Meanwhile, the credit freeze remaining from the Great Recession of 2008 will continue to thaw, but money is likely to be tight for all but the best risks.

“You are going to see 2012 being very much like 2011,” says Dennis Lombardi, executive vice president, foodservice strategies for WD Partners, a suburban Columbus, Ohio-based design and consulting company.

“Traffic will be relatively flat, and price taking (hikes) will be just enough to cover commodity costs that will likely move slightly higher,” he adds.

Bonnie Riggs

Bonnie Riggs, restaurant analyst in Chicago for the market research company NPD Group, says the industry is “not going to see much movement” in 2012. Sales and check totals will tick ahead marginally from 2011, but traffic should be slightly lower.

“It’s not a very positive forecast for the restaurant industry,” she acknowledges, pointing out that consumers remain nervous. “It’s all about consumer confidence. There’s a very close relationship between the trend for consumer confidence and restaurant traffic.”

Lombardi believes the best economic indicator for the restaurant industry is the total sum of people working – particularly full time.

“We are still way under the number of jobs that there were before the recession, and we are not seeing any real substantial growth to keep up with the number of people joining the workforce,” he says. “Unless there is a miracle, that is not likely to change in 2012.”

Ken Mayland

The stubborn jobless numbers are part of an overall economic malaise that has dampened consumer and business confidence, according to veteran economist Ken Mayland of suburban Cleveland-based ClearView Economics.

“It’s something I haven’t seen before, and I’ve been around a long time,” he says. “We are in a recovery of sorts, but a recovery where very few businesses want to commit to the future in a meaningful way – either in hiring or making long-term capital expenditures.”

The result has been rampant economizing that helped companies chalk up good profits, but left the nation’s overall growth limping along.

“Two years out of a severe recession, we should be in the sweet spot (of a recovery), with high growth. Instead, we’re basically stuck in neutral,” says Mayland. “The public sees the high unemployment rate and thinks the recession never ended.” Business, already gun-shy from the recession, remains cautious because of slow economic growth.

Research from NPD determined that independent restaurants are suffering most from the economic weakness. The industry as a whole lost 9,500 restaurants during the 12 months that ended in March or about 2 percent, and the vast majority of the closed restaurants were independents.

“It’s going to be a long, slow recovery for the industry in general, but it’s been very difficult for the independents,” who don’t have the cash reserves and access to credit to remain viable in difficult times, Riggs says.

If there’s any good news for the restaurant industry, it’s that there is forward momentum, even if it’s tenuous. The National Restaurant Association’s Restaurant Performance Index was in positive territory most of 2011.

That signifies expansion for the industry.

Hudson Riehle

“That modest growth environment will continue into 2012,” forecasts Hudson Riehle, senior vice president of the association’s Research and Knowledge Group. “Restaurant operators are generally optimistic about sales growth into the next year.”

Riehle cited “substantial” pent-up demand by restaurant customers, although actual visits depend heavily on employment.

“When more people are working, there is more demand for convenience, and there are direct correlations between income gains and restaurant sales growth,” he says.

Therefore, states showing job growth, such as North Dakota, Wyoming, Utah, Texas and Oklahoma, are also experiencing stronger restaurant gains than a state like Georgia, where the job situation had been deteriorating.

Economic consulting firm Moody’s Analytics predicts the South, Southwest, Mountain and North Central regions will have the best job growth during 2012. States losing employment are likely to be the District of Columbia, Maryland, Connecticut and Vermont.

Although the Restaurant Performance Index generally did well in 2011, it hit a bump during the summer, when the ongoing political rift in Washington broke out in a full-blown crisis over federal spending and the debt ceiling.

Although this deadlock was eventually ended by a delicate deal, the damage was done. The most telling action came when Standard & Poor’s downgraded the U.S.’s credit rating for the first time, citing the broken political process and an inability to substantially reduce record budget deficits.

The stock markets roiled, and consumers became just as nervous. Restaurants were not immune.

“The policy debates that occurred … around the budget deficit, along with the downgraded U.S. credit rating, caused the consumer to form a more pessimistic view about the future of the economy,” Doug Brooks, chief executive and president of Brinker International Inc., told investors during a conference call in October.

“The industry felt the impact in our business from those economic headwinds,” he said.

Brinker owns casual chains Chili’s and Maggiano’s Little Italy and has a minority stake in Romano’s Macaroni Grill.

Similar budget fights are likely to occur in the months leading up to the 2012 general election, when President Barack Obama will face a Republican challenger, and that could cause the economy to lose momentum at times.

And the election itself “will just add to all the uncertainty,” adds Mayland. “No one knows what policy may be like in 2013.” Business also will wait the Supreme Court’s eventual decision on the national health-care law before making some decisions.

Although the U.S. debt situation is bad, it’s even worse in Europe, where several countries have had to take drastic cost-cutting measures to keep from defaulting. Economists now worry that could spill over and infect the American economy.

Another damper on growth is the overhang of foreclosed homes and the weak housing market.

“Working off the high level of foreclosures is a drag on some regions’ economies,” Mayland notes. “That should continue for some time.”

Veros Real Estate Solutions, a Santa Ana, California-based national property valuation firm, finds that the strongest housing areas are similar to those with the best job growth, including the Great Plains and oil-rich Texas and Louisiana. Weakness will linger in Las Vegas, the inland West and some Florida and Arizona markets.

“What goes on in the local economic infrastructure directly impacts how restaurants perform,” says Riehle. “So, whether it’s the soft residential market or consumers deleveraging themselves (from debt), having cash on hand makes a difference.”

A major fiscal issue directly affecting restaurant operators will be commodity prices, both for agricultural and energy products.

“An area of concern I have is food-cost inflation,” says Mark Kalinowski, lead restaurant analyst for Janney Capital Markets, a Philadelphia-based investment firm.

“Food costs are high compared to historical levels,” he says, “and if we see another bout of food inflation, brands that don’t have the pricing power are in for a struggle to maintain margins, let alone grow them.”

Weather is a wild card when it comes to forecasting the supply of commodities, but the world’s population continues to rise, meaning there will be more demand for food.

“The fundamental strategic challenge we face in the near term is how to address the growing need for affordability that’s demanded by our guests, while also protecting our margins, given significant commodity cost inflation,” Andrew H. Madsen, president and chief operating officer of Darden Restaurants Inc., told investors in September.

Large chain operators such as Darden, which operates both casual chains (Red Lobster, Olive Garden and others) and fine-dining units (Capital Grille), know they can’t raise prices more than a couple of percent without risking a loss of customers. At the same time, they need to pass on some of the costs of more expensive commodities.

The guest can’t absorb all of the commodity-price increase, says Bruce Kraus, director of operations for Fort Wayne, Indiana-based steakhouse chain Eddie Merlot’s. “As a business operator, you have to find other ways to deal with that pressure.”

Many operators have been able to do that through increased efficiencies, greater focus on dayparts other than dinner, and new menu items that carry price points to entice consumers without being deep discounts.

Chains decided that it’s also important to give up a little on the bottom line to retain market share.

“If you lose market share, you may find your concept is unable to participate in the recovery because you’re not relevant,” says Robert M. Derrington, managing director and restaurant analyst for Memphis, Tennessee-based investment firm Morgan Keegan & Co.

Value-conscious consumers simply stop visiting those restaurants.

“I think 2012 is going to be a very, very fine dance between menu pricing, commodity costs, traffic growth and the mix of what you serve,” he explains.

For independents like Pat Connors, owner and general manager of Pastiche Modern Eatery in Tucson, Arizona, a little creativity helps battle rising commodity prices.

“We have moderated our menu,” he explains. “Instead of raising prices, we looked at menu alternatives. We are continually refining that.”

In the past, operators could moderate some higher commodity prices because other food costs were going down. “But when all the commodities are rising, you have to take an alternative approach,” notes Connors, president of Tucson Originals, a group of independents. “You still want butts in the seats, but you don’t want to lose money.”

Large chains can use forward contracting to hedge against sharply rising commodity prices, but even that may just delay paying the piper if food costs keep going up.

“We don’t think things are going to get a lot better than they are today, but not necessarily a lot worse,” Brooks said at Brinker’s investor conference call.

While operators are being pressured by higher food costs, they also suffer when the price of another commodity, gasoline, goes up.

“When we saw gasoline prices in the spring shoot up to $4, that was the threshold when consumers stopped going out to restaurants,” NPD’s Riggs says. “We were starting to see the light at the end of the tunnel, and then, boom.”

Gas prices are sensitive to a wide array of economic and political forces, many of which are impossible to predict. However, an improving world economy would mean more demand for oil, and, thus, higher prices.

Another factor that is not likely to charge in 2012 is tight credit for smaller and independent operators.

“We are not going to go back to the days of easy credit for a number of years, if we go back there at all,” Lombardi says.

For operators like Connors, that means putting capital expenditures on hold.

“Some of us are looking at buying equipment, including some big pieces that would make our businesses operate much more efficiently,” he notes. “But then we think this can wait because we don’t have the money to make the purchases.”

On the other hand, restaurants of all varieties can expect to have access to prime real estate if they show good balance sheets and solid unit economics. That’s because property owners, hit hard in the recession by broken leases from failed retailers, are looking for operators who are likely to succeed. Blockbuster profits are not a requirement.

Glen Kunofsky

“There is a flight to quality,” says Glen Kunofsky, senior vice president in the New York office of Marcus & Millichap, a national investment real estate broker. Owners will provide top-notch locations at a good price for consistently performing tenants.

He expects restaurant development to increase this year, especially by publicly owned chains that need to show investors they are expanding. There also should be more sale-leasebacks by operators looking to raise cash to pay off debt or boost the bottom line.

There are also plenty of deals available when it comes to non-prime property, notes John Gorham, chef and owner of three restaurants in Portland, Oregon, including Toro Bravo, a critically acclaimed neighborhood tapas eatery.

Landlords “just want you to sign on the line,” he says. For his newest venture, located in a good, but not prime location that previously housed a restaurant, he got three months’ free rent plus a functioning kitchen, main electrical grid and full plumbing.

“If you can show a history of growth, they want you,” he says.