Deflation Could Be Coming To Casual Dining

For the first time in recent history, restaurant operators could benefit from a period of deflation, which could help boost their bottom line.

In a report published September 24, BMO Capital Market analyst Andrew Strelzik commented that the outlook for key protein and dairy inputs implies 2016 will "mark the first year in recent history" in which food costs turn deflationary.

Role Of Casual Dining Concepts

Strelzik continued that casual dining concepts could be tempted to become increasingly promotional next year in a deflationary environment to boost traffic.

However, the analyst pointed out that from a historical perspective, a more promotional casual dining environment does not guarantee a boost in comp trends, and comps have even weakened for several operators in an environment of heavy promotional activity.

"We believe promotional activity is a more likely lever to be utilized in an effort to drive traffic than more limited pricing as companies largely have indicated intentions to maintain recent pricing trends to offset accelerating labor inflation," Strelzik wrote. "The potential for promotions to increase with lower food costs is supported by the historically solid inverse relationship between changes in food costs and casual dining steak and Italian segment promotional levels, as measured by NPD Crest."

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Company Specific Commentary

Strelzik stated that his "favorable outlook" for Buffalo Wild Wings BWLD remains unchanged, as a favorable shift in the sports calendar should support comps "well ahead" of expectations. The analyst noted that Buffalo Wild Wings has historically shown "no meaningful relationship" with changes in promotional activity.

Texas Roadhouse Inc TXRH may see a comp deceleration heading into 2016, and the stock has "yet to reflect the slowdown." Moreover, the restaurant operator is one of a select few whose comps are "solidly" inversely related with changes in promotional activity. As such, the analyst sees "risk" to the stock's valuation as a slowdown in comps is realized.

Strelzik also sees risk to Brinker International, Inc. EAT's 2016 comp expectations, as the company has also seen no correlation between increased promotional activity and comps. Meanwhile, the consensus estimate is already forecasting a 140 to 150 basis point comp acceleration.

Finally, Strelzik sees a "potential risk" to consensus 2016 comp expectations for Bloomin' Brands Inc BLMN. However, the analyst suggested that the stock's valuation already "reflects exceedingly low expectations," while management holds several "strategic actions" that can support the company's earnings and stock.