Restaurant stocks are no longer fitting the bill as they slip into what analysts are calling a “restaurant recession” amid rising labor costs and flat sales growth.
Over the past six years restaurant stocks experienced substantial growth so companies didn’t immediately see any danger ahead. The industry reached a peak this summer with the the Dow Jones U.S. Restaurant & Bars Index (DJUSRU) increasing roughly 77 percent from July 2011 to July 2016.
Dow Jones Bar and Restaurant Index over 6 years
But over the summer analysts at both Stifel and Jefferies downgraded their outlook for the sector, citing historical restaurant cycles and increasing competition of private corporations.
During the past 6 months, restaurant stocks started to underperform. Currently the DJUSRU is down 5.59 percent after a steady decline beginning around April. The restaurant index continues to lag behind the S&P 500 Index, up 4.61 percent.
Dow Jones Bar and Restaurant Index vs. S&P 500 Index
More recently individual restaurant company stocks have seen declines in value. Since July Cracker Barrel Old Country Store, Inc. stock has dropped 22.07 percent, Texas Roadhouse Inc. declined 13.96 percent, and even fast-food giant McDonald’s Corporation saw a decline of 4.19 percent.
Last month global information company, The NPD Group reported restaurant traffic stalls for the second quarter of the year. Even quick service restaurants experienced flat sales growth.
NPD group analysts attribute the slowdown to overall economic uncertainty as well as increasing food prices at restaurants.
“Uncertainties have put a damper on overall consumer spending,” NDP Group analyst Bonnie Riggs said in the release. “Compounding the situation for the restaurant industry is the decline in food at home inflation while at the same time restaurant operators have been increasing menu prices.”
In August the Bureau of Labor Statistics reported a decline in prices for “food at home,” while “food away from home” prices, prices among full-service restaurants, fast-food spots, and other outside food outlets, have continued to rise. Food away from home prices increased 2.8 percent over the past 12 months.
The increasing gap between the two categories is creating more competition for consumer traffic among grocers and restaurants.
In addition to pricing concerns, wage growth is expected to have a damaging effect on restaurants over the next few years.
A report on wage inflation by Credit Suisse found that significant increases in the federal minimum wage would create a decline in restaurant earnings. On average, labor costs for the industry account for roughly 30 percent of their revenue. To compensate for the rise in labor cost restaurants would have to further jack up menu prices or cut costs in other areas.
“We believe companies may have a difficult time covering costs with more pricing should labor inflation continue to rise from current levels,” Credit Suisse analyst, Jason West, noted in the report.
If the federal minimum wage moves to $10.25 an hour by 2020, the report suggests the industry could see minimum wage inflation of roughly 7.9 percent from 2018 to 2020. The report states this scenario would be most likely in the result of a Hillary Clinton presidency given her public support in the past of a minimum wage movement toward $12/hour.
States such as California and New York are already experiencing minimum wage increases and higher labor costs. According to the report, companies with high exposure in these areas, such as Starbucks and Shake Shack, may not be as heavily affected by wage inflation. These corporations have already prepped labor investments to combat rising costs.
Though wage increases could create an economic environment for increased consumer spending, the cost of labor could prove to be harmful to most restaurant companies.
However, the report noted that along with increases to menu pricing, additional technological innovations and franchising restaurants could offset potential wage inflation.
Although wage increases are likely to affect most of the industry, analysts are more optimistic about fast-casual restaurants such as Chipotle Mexican Grill and Panera Bread, as well as a few innovative full-service companies.
Canaccord Genuity analyst, Lynne Collier, rated 11 restaurant stocks as hold in August, but gave 4 stocks buy ratings. Buy stocks included Panera, Sonic, Dave & Buster’s and Darden Restaurants, which owns Olive Garden and Longhorn Steakhouse.
Panera Bread, receiving a $255 price target from Canaccord Genuity, benefits from its use of mobile technology and digital ordering. Sonic and Darden received buy ratings because of their growth potential despite the fears of wage inflation.
Collier wrote that Darden favors from menu innovation, as well as remodels of their Olive Garden restaurants and use of table-top tablets.
“Darden’s portfolio of brands offers diversification and strong average unit volume,” Collier wrote in the report.
Despite positive labor reports and solid consumer confidence pointing to a stronger U.S. economy this year, most of the restaurant industry may not reap all the benefits.