Eating out in the United States has almost become a national pastime. An astoundingly large industry has been built around the American consumers’ desire to, well, consume. But the expansion of the US restaurant industry looks to be grinding to a halt and we think this could be the structural driver of a number of short opportunities.
The restaurant industry in the US comprises over 1 million venues which generate total annual sales of around $800 billion, accounting for around 4% of the entire economy. The industry also employs almost 15 million Americans, or nearly 10% of the total workforce in the US. Half a decade ago, as the accessibility of the car lent itself to driving trips and eating experiences further from home, sales at US restaurants were growing at double digit rates year in year out. More recently however the growth rate has slowed significantly reflecting the maturity of the industry as a whole and changing consumer behaviour.
Broadly speaking the US restaurant industry consists of sit-down, or full service, restaurants (FSRs) and quick service restaurants (QSRs). FSRs typically provide table service and account for 19% of restaurant traffic in the US. QSRs are more typically in and out fast-food venues (think McDonald’s) which account for 81% of restaurant traffic. Both FSR and QSR numbers have been growing at low single digit rates for the past few years. However, this growth has been offset in 2016 by sales declines at individual restaurants. So-called same-store-sales (SSS) growth turned negative earlier this year.
US restaurant unit growth vs population growth
US restaurant same-store-sales growth
Intuitively this makes sense. The informal dining out market has been around for a long time and is no longer a new thing. Everyone that might want to eat out is already doing so, and they are doing it as frequently as they please. In other words, the industry is mature and should probably only grow along with the population of the US. Unfortunately for restauranteurs the US population is growing at less than 1 percentage point per year. The simple math says that opening restaurants any quicker than this will eat away (pun intended) at the sales of existing venues.
Worse still for the US restaurant industry is the declining value proposition that dining out provides. Over the past two years the cost of groceries or food at home (FAH) has declined along with declining commodity costs and intensely competitive food companies and grocery stores. At the same time, faced with slowing sales and declining traffic restaurant operators have been increasing menu prices resulting in an upward march in the cost of food away from home (FAFH). The cost of dining at a restaurant is now 15% more expensive than in 2011. More importantly it is 10% more expensive relative to eating in than it was 5 years ago, as illustrated by the widening “jaws” between the blue and red lines in the chart below. The cost of eating out has even outpaced wages, as measure by average hourly earnings (AHE) and represented by the green line below, so a greater share of weekly pay checks is now required to buy the same restaurant meal.
Dining out and grocery prices vs wages (indexed to 100 as at August 2011)
While an oversupplied industry and overpriced product is creating headwinds for restaurant sales, we see little reprieve for the industry’s costs. Restaurant costs are typically dominated by labor costs which can account for 40 to 50% of the overall cost structure. Since the beginning of 2015 wage inflation has started to accelerate in the US, supported by increases to legal minimum wage levels which apply to many restaurant workers. As an example the minimum wage in the state of California is now $10 per hour, and is expected to increase by 50 cents per year, with many calling for a new minimum of $15. This equates to almost half the cost base growing at 5% annually, contributing to 2.5% cost growth before thinking about rent escalators and the potential for commodity costs to rebound.
US wage inflation
Said another way a restaurant operator needs to achieve at least 2.5% sales growth at each venue just for profitability to stand still. In the context of a slow growing population, a mature restaurant industry, exhausted pricing power and declining traffic statistics it might be tough for a lot of restaurant companies to achieve any top line growth at all. Such businesses may not be able to keep their heads above water for very long and we keep trawling each day intent on adding them to the Montaka short portfolio.
Christopher Demasi is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.