Will Food Price Inflation Hurt Restaurateurs? - Analyst Blog

The U.S. Department of Agriculture (USDA) has indicated that the economy will witness a rise in food prices in 2014. After staying at a modest 1.4% in 2013, the consumer price index (all food) is most likely to witness a 2.5-3.5% jump this year. This should take the food price inflation back “to a range closer to the historical norm.”

Thus, it is for investors to wonder what happens with the restaurateurs or food sellers and how well can they tackle food price inflation.

What food chains need to focus on is strategies that will help them mitigate the increased cost, if at all they are impacted. Implementing the right pricing strategy, increasing global presence and focusing on supply chain revenues may be some of the escape routes.

Meat Prices to Go Up

The highest price inflation for foods consumed at home is expected to be seen in beef, veal and poultry prices. The jump could be as high as 3-4% year over year. The report noted: “Beef prices are on the rise due to a lower than average supply of cattle resulting from the lingering effects of the 2012 drought.”

This, however, is not expected to immediately dampen the nation's popular meat products seller Tyson Foods, Inc. TSN. Earnings estimates for this Zacks Rank #1 (Strong Buy) stock have been moving north for both the current quarter and year, and it commands a current year growth estimate of 32.2%. That compares favorably with industry growth estimate of 18.6%. Also, Tyson was recently picked as one of “America's Most Admired Companies” by Fortune magazine.

Does Passing the Buck Work?

Given the highly cost-sensitive nature of the industry, it often becomes difficult for the restaurateurs to immediately pass on the burden to customers. Here comes the worry part for investors. Higher prices may result in higher revenues, but that may come along with a drop in profit margins.

Retail prices may not always follow the uptrend of commodity prices. Domino's Pizza, Inc.'s DPZ vice president of communications Tim McIntyre believes the “industry is far too competitive for that.” What Domino's can do most is pass higher commodity costs to restaurant customers, with a fixed dollar margin. It may not result in higher profits though.

Cheese is about 40% of Papa John's International Inc.'s PZZA food cost. Bloomberg data notes that since December the prices of mozzarella cheese and cheddar cheese jumped 16% and 25%, respectively. However, we have not seen any retail price hike of late.

What happens in these cases is that a drop in other ingredient costs offset the hike. A record harvest last year had substantially brought down dough prices. Also, franchises may cut back on promotion activities. They may instead try and boost the sales of non-cheese menu items. Thus, the restaurateurs need strategies that will hedge price changes.

Supply Chain Revenues

Domino's Pizza may be known for its pizzas, but its primary business of selling pizza ingredients like cheese, toppings and dough to company-owned stores and franchises help it earn higher revenues. The supply-chain business ranges from ingredients to selling restaurant equipment. This business contributed 56% to sales while retail contributed only 19%.

Also, Papa John's International self-termed “domestic commissary” contributed 40% of sales. This is the ingredients business of Papa John's.

Global Presence Looks Bright

With a fast growing and prosperous middle class, emerging markets like China and India have emerged as the destinations of choice for many restaurateurs.

Domino's Pizza's comps further affirm the necessity to grow globally. Its fourth quarter domestic stores comps rose 3.7%, well short of 5.4% growth in third quarter and the year-ago level of 4.7%. However, international stores recorded 7% growth (foreign currency translation excluded). The international comps were also better than the third-quarter comps of 5% and the year-ago level of 5.2%. Domino's has a Zacks Rank #3 (Hold) now.

Here, investors may focus on Yum! Brands, Inc. YUM. The owner of KFC, Yum! Brands is claimed to be the fastest growing quick service international brand. Currently carrying a Zacks Rank #2 (Buy), this industry behemoth is also seeing decent upward earnings estimate revisions. The current year growth estimate of 22.2% outshines the industry estimate of 8.8%.

Baskin-Robbins owner Dunkin' Brands Group, Inc. DNKN is another solid choice here. It too carries a Zacks Rank #2 (Buy) and has seen solid upward estimate revision. Its two brands, Dunkin Donuts and Baskin-Robbins, have gained decent popularity in Asia and the Middle East. These regions respectively contributed 73.8% and 13.6% of 2012 international franchise sales. Baskin-Robbins in particular generated 87% of international revenues.

Strategy of Pricing and Menu

The price and menu options, often an outcome of right strategy, may influence a consumer on which restaurant should he or she visits. What consumers usually look for is the perfect blend of price and product they receive.

On that note, The Wendy's Company WEN was prudent to usher in its Right Price Right Size strategy last year. This “value menu” offered several items at 99 cents and others priced up to $1.99. The “Dollar Menu” largely popularized by McDonald's MCD had actually items worth even $5. So, looking at food below a dollar must be an instant catch point for customers looking for quick snack. Also, Wendy's need not worry about keeping food prices restricted to a dollar, as its strategy name promises nothing of that sort.

Wendy's President and CEO Emil Brolick had commented that the rollout of the strategy was to win back the share in the value-menu area. This came soon after Wendy's reportedly toppled Burger King Worldwide, Inc. BKW to snatch the second position in its domain. A better focus on its servings (square patties) was adjudged to be a key catalyst. Wendy's had been aggressive in revamping its menu since 2008.

From being a Zacks Rank #4 (Sell) early last year the company quickly moved up to being a top-ranked stock in May 2013. The rank thereafter had dropped to Zacks Rank #3 (Hold). The company currently sports a Zacks #1 Rank (Strong Buy) and should be a solid choice for investors.

The company recently introduced two new salads on its menu: Asian cashew chicken and BBQ ranch chicken salad. The National Restaurant Association has rated the Asian and Barbeque flavors among the top food trends for 2014, making these an easy choice to gain market share.

Healthy Diet & Innovations

Talking of healthy diet and the American's growing health consciousness, it becomes important for these companies to offer foods with health benefits. First Lady Michelle Obama has been active in continuously pushing the healthy diets. U.S. eateries are serving a healthier menu to cater to consumer preferences for fresh, organic, nutritious and low-calorie food.

Investors may pick Zacks Ranked #2 Jamba, Inc. JMBA, which is scoring well on the healthy menu options. Jamba's unit Jamba Juice Company recently launched two nutritious items: Kale Orange Power and Kale Whole Food Boost. The consensus estimate trend for the year has been improving over the last month. Add to that, Jamba has a staggering current-year growth estimate of 134.6%.

Conclusion

Not always will a dismal general trend hamper the bull run of a particular company. But for that to happen, companies must get their hedging actions in order. Thus, key strategies will help these companies to offset any damage that food inflation may cause. For investors, too, these positive-ranked companies will most likely be a treat.

Happy dining and happy investing!