Restaurant same-store-sales decreased 0.6% in August, marking the third consecutive month of negative same-store-sales growth (on a sequential basis) for the restaurant sector. It was also the sixth month since the beginning of the year that sales declined on a year-over-year basis. Weak traffic was once again the culprit. Traffic fell 2.7% in August, and is down 3.4% on a rolling 3-month basis. Average check increased 2.3%, which helped offset some of the customer losses, but the increase in average check decelerated and the overall growth is distorted by a few fine-dining restaurants which have pricing power. Most restaurants lack pricing power and grow comps primarily through traffic. Restaurants will continue to struggle for traffic throughout the year, and we remain bearish on restaurant stocks (NASDAQ:BITE) as a whole.
Restaurants have been slowing the pace of menu price increases and offering more promotions in an attempt to drive traffic. Analysts note that while this practice usually has an "underwhelming" impact on sales, it has been more effective in recent times. Fast casual, family dining and casual dining segments all reported a deceleration in average guest check growth but improved traffic growth by more than 1% in August over July. The exception was fine dining, a segment with more pricing power, that continued to grow average check and increase traffic. The changing relationship between average check and traffic suggests that the US economy is getting weaker and that consumers are more sensitive to price (I have written about this in a number of articles throughout the year). It is therefore not surprising that quick service players (which emphasize price, value and convenience) were the best performers in the restaurant space in August (in terms of same-store-sales) for the seventh consecutive month.
But many "economists" continue to ignore the obvious signs of weakness. Analysts point to seemingly strong jobs growth stats as evidence that the economy is healthy and expect GDP to grow 3% in Q3. This kind of growth is unlikely given that the economy grew just 1.1% in both Q1 and Q2. If anything the data is getting worse (retail sales fell 0.3% in August), and these analysts would have a lot more credibility if they based their forecasts on actual data rather than just spewing out a number. The jobs numbers they point to are only strong on the surface. Most of the jobs added are part time jobs in low-paying service sector roles. Part-time jobs count as much as full-time jobs in the payroll report and in the calculation of the unemployment rate, but they shouldn't. Just like last quarter, we expect GDP in Q3 to come in much weaker than expected.
At the same time, restaurants will continue to face pressure on the cost side due to rising labor costs. Labor costs as a percentage of sales have increased from 29% to an average of 32% of sales during 2016. Minimum wage hikes and high worker turnover are the reasons. High turnover results in a lot of vacancies so new hires comprise a relatively high portion of restaurant firms' workforces, and this raises costs. But turnover is also high among restaurant managers, and this is a worrying sign given the historical inverse relationship between management turnover and subsequent traffic and sales growth. Turnover is at higher levels than before the recession and if past relationships have any validity, things are more likely to get worse rather than improve for restaurants during the next year.
The latest restaurant industry report reinforces my belief that the US economy is fundamentally weak. Consumers have become more sensitive to price and are eating out less frequently. Restaurant stocks are not the place to be during a recession, as they are highly sensitive to disposable income fluctuations. The majority of the stocks that comprise The Restaurant ETF still trade at growth valuations (a result of buybacks rather than underlying performance). We think many of these stocks have further to fall.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in BITE over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.