According to analysts, the prospects for restaurant stocks are quite appealing as the space absorbs commodity inflation and works towards reducing staff shortages.
Food away from home was one of the highlights of Wednesday morning’s CPI report. Although the food at home index posted a 12.2% increase from the year before, the largest annual increase since 1979, food away from home rose slightly by only 7.7%, while service meals rose 7.4% over the same time frame.
Even though both indexes posted the largest increase in more than 40 years, restaurant stocks recorded substantially lower inflation, implying that they had the capacity to absorb increasing costs. In addition to this, Cowen Research suggests that there are signals indicating that inflation’s impact on things like chicken breasts, wheat, and more is peaking in the current quarter.
Cowen analyst Andrew Charles noted that checks with CEOs at multiple fast food casual chains suggested that food costs are set to reduce in the third quarter.
“Commodity inflation was acute in Q2, in particular chicken breast, wheat, packaging & Freight,” Charles said to clients. “Encouragingly, both panellists suggested cautious optimism that commodity costs have peaked, with more meaningful relief expected in the coming months as oil prices have tapered, a leading indicator of soft commodity costs.”
Nick Setyan, analyst at Jefferies also seems to agree with Charles. He recently said that every restaurant investor should hope for a recession similar to what happened in 2008 since the price increase would soften the impact on overall comps from reduced transactions.
Charles believes that this could be a critical point that predicts the future of the companies set to report in the upcoming earnings season.
Fast Casual Restaurant Stocks Could Benefit From Lower Inflation
The lower inflation across quick service and fast casual restaurant stocks compared to inflation in full-service at 8.9% will most likely help in a trade-down impact. This will be a significant advantage for companies like Chipotle Mexican Grill (NYSE:CMG), Shake Shack (NYSE:SHAK), and Sweetgreen (NYSE:SG) and quick service restaurant stocks like McDonald’s (NYSE:MCD) and Yum Brands (NYSE:YUM).
The increasing inflation levels at sit-down service restaurants as well as casual dining appears to have been responsible for the outperformance in the comparatively cheaper sectors.
In another major highlight for the restaurant sector, Cowen revealed that declining labor shortages were the most significant source of optimism in their talks with CEOs. Charles believes that the loose labor environment is likely to help normalize prices and, at the same time, aid in service delivery.
Shake Shack (NYSE:SHAK), Sweetgreen (NYSE:SG) Portillo’s (NYSE:PTLO), Domino’s Pizza (NYSE:DPZ), Kura Sushi (NASDAQ:KRUS), Wingstop (NASDAQ:WING), Jack in the Box (NASDAQ:JACK) and Restaurant Brands (NYSE:QSR) led gains in the space prior to Wednesday’s close.
Just to be clear, this optimism does not cover the whole restaurant space. Data from placer.ai urges caution on the backdrop of casual dining trade down and coffee chains experiencing slowing sales. Coffee visits dipped below QSR levels for the first time this year in June due to a combination of increased COVID cases keeping customers away, inflation and higher gas prices, according to the report.
The decline in foot traffic was apparent at both chains in June, as visits dipped 7.8% year-over-year at Dunkin’ Donuts and 4.1% at Starbucks (NASDAQ:SBUX).
Dutch Bros (NYSE:BROS) was the only outlier in the coffee space after reporting a 22.8% increase in foot traffic in June, according to the data.
For restaurant investors, the most essential thing to take note of is the fact that valuations are at or near a trough. A quick look back at company-owned restaurant stocks and franchise valuations during both the financial crisis and COVID-19 crisis reveals that the current valuations offer quite an appealing risk/reward proposition.
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