There are always winners and losers in this industry. The restaurant industry continues to be one of the most important portions of the US economy. It represents something like 14% of the US workforce, and generalized consumer spending reflects 65-70% of the economy. Labor trends, cost patterns affecting commodities, insurance, occupancy and other expense categories are reported by way of public companies on a quarterly basis. Moreover, since dining habits quickly reflect the public’s self-perceived well-being, reported sales trends provide a real-time “state of the economy.”
Two thirds of the publicly held restaurant companies have reported in the last two weeks, and it is clear that the economy has materially softened. Only a handful of companies have reported positive traffic year-over-year, with many still flat or worse off since 2019. While Wingstop has been the most dramatic exception with an amazing 28% quarterly comp, Texas Roadhouse, CAVA, Chipotle, Shake Shack and Sweetgreen have their particular upbeat stories to tell. Traffic and sales trends have finally flattened everywhere else, including excellent operators such as First Watch and STK (the One Group), respectively.
Where do we go from here? Let me assure you that there are always winners, incubating beneath the surface. Food prepared away from home continues to be in demand…..for long standing socioeconomic reasons. However, sales trends are not likely to firm up in the next few months, with the distraction and uncertainty relating to our national election and higher back-to-school spending. Longer term, debt service continues to be a factor. Though it will not get any easier, decide whether your chain provides a “fuel stop” or an “experience” and then somehow exceed customer expectations. Easier times will come, for the restaurant industry first, and the broader economy a matter of months later.
My macro view is hereby adjusted. I expected interest rates to be higher for longer, but that seems in doubt. I expected the enormous supply of fixed income paper, approaching one trillion dollars monthly from the U.S. alone to keep rates high, even though the annual interest expense is approaching $1 trillion dollars annually. With a declining inflation rate, coupled with the public’s spending slowdown in restaurants and retail, it would suggest that inflation could “blow through” the 2% target and keep going down.
More important than my judgment is the public’s inflation expectation and creation of a self-fulfilling prophesy. In that regard, the New York Federal Reserve’s July Survey of Consumer Expectations showed a “median three year ahead inflation expectation of 2.3%, the lowest since this survey began in 2013.” If a true price reduction happens, (the Fed’s nightmare), a broad deferral of consumer spending could come into play. This is much harder for the central bankers to deal with, as demonstrated in Japan, where they’ve propped up the economy for decades with enormous spending, by keeping interest rates at or below zero. I would suggest the Fed’s habitual “too little too late” approach could surface once again. That said, I don’t expect a 1930s type of deflationary depression. I expect that the rate cuts that were expected six-to-twelve months ago will come into play once again, perhaps two or three cuts between September and December. The Fed will “rescue” us once again, by financing the Federal spending that will keep the economy growing in nominal terms if not very much on an inflation adjusted “real” basis. Another “transitory” inflation round comes later.
Private equity and activist institutional investors have had more than a few big winners (and some losers, to be sure) within the restaurant industry. Bill Ackman’s Pershing Capital has made a fortune in Chipotle over the last five years. Gemini Investors and Roark Capital scored big with Wingstop and TSG Consumer Partners just finished liquidating their huge profit in Dutch Bros. While it is always eye-catching when an “activist” investor takes an interest in a apparently inexpensive and perhaps troubled situation, I always offer a note of caution. I recommended Bloomin’ Brands (BLMN) at $28/share, and personally bought stock after Starboard Value took a position, negotiated Board seats, and brought in a highly qualified ex-Darden executive to help. BLMN is $16 per share today, so there has been no magic so far. Obviously unfazed, Starboard has even more recently established a stake in Starbucks, was accepted on the board, and has now been joined by Elliot Management, another well regarded activist group. These smart guys just got lucky with Brian Niccol leaving Chipotle for Starbucks. Nervous CMG investors should consider that Scott Boatwright, previous COO at Chipotle has moved up to “interim CEO” and some observers believe that Boatwright has been at least as instrumental as Niccol. Optimistic SBUX investors should consider that 40,000 stores worldwide is a pretty big boat to turn around. Whatever develops at BLMN or SBUX, it will not be because of Starboard or Elliot, who cannot improve the discretionary income of the dining public, or overcome the increasingly competitive industry dynamics.
Roger Lipton
