One Analyst's Surprising Indicator Why Recession Is Coming In Early 2017
by Tyler Durden
Jul 26, 2016 11:23 AM
Stifel analyst Paul Westra downgraded the restaurant industry in a note released today, slashing estimates and ratings on 11 stocks in the sector, while warning that a slowdown in the restaurant industry is a harbinger for an overall economic recession.
The report warns that the restaurant industry is facing a perfect storm of slowing demand, rising minimum wage mandates across the country and minimal opportunity for commodity cost declines. This fits with the thesis laid out by KeyBanc analysts last week, suggested last week when upgrading Papa John's Pizza on the expectations that the recent surge in political unrest and terrorism fears would prompt more Americans to stay at home and order food instead of eating out.
As Westra says, "Today, we adopt a bearish outlook for restaurants as we confidently believe that, at a minimum, the simultaneous -150 basis points to -200bps deceleration of restaurant industry comps across all categories during the second quarter within our most recent Stifel Sales Survey reflects the start of a U.S. Restaurant Recession"
However, it won't be just a "restaurant recession" - according to the analyst, the weakness would promptly spillover to the broader economy: "restaurants have historically led the market lower during the three to six-month periods prior to the start of the prior three U.S. recessions."
To wit, Stifel highlights prior recessionary periods in the US have been preceded by 200-300bps declines in restaurant industry comps during the 3-9 month periods leading up to the recession. To that end, the report points out that 2Q16 comps averaged 70bps down from 250bps in 3Q15, reflecting a 180bps decline over the period, which Stifel warns reflects the start of the restaurant recession and likely is a harbinger for a US recession in early 2017.
The charts below illustrate that the 2001 and 2007 recessions were preceded by a substantial deceleration of restaurant comps over the 24 months leading up to the recession. In tracking the current cycle, the deceleration in comps since January 2015 appears to be even more pronounced than the 2001 and 2007 slowdowns.
Stifel contends that Wall Street is often slow to recognize recessionary signals from the restaurant space (or any other ones, we might add) as models tend to underestimate the relative pricing power (price increase less input cost inflation) collapse that occurs during downturns in the industry. As a result, the low marginal cost of each incremental meal sold relative to the high fixed costs associated with rent and employee overhead causes the worst performing concepts to chase short-term cash flow through price cuts which simply serves to deepen and prolong the contraction.
What makes this cycle potentially worse is that demand weakness in previous cycles was somewhat offset by commodity price declines. In this cycle, however, commodity prices have already collapsed leaving minimal opportunity for further cost deflation from here.
Moreover, the labor cost side of the restaurant equation is only getting worse as well. Stifel, points out that 60% of the U.S. population lives in states where the 2017 minimum wage is expected to increase 2.8% YoY led by a 15.4% increase in New York, 10% in Massachusetts and 6.8% in California.
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Is Westra right? We will get the answer shortly, when the bulk of public restaurant companies report earnings in the coming days and weeks as they report earnings. Panera Bread Co. and BJ's Restaurants are set to report results after the close today, while other prominent chains like The Cheesecake Factory, Texas Roadhouse, and El Pollo Loco report over the next two weeks.
So far the "eating out" picture has been gloomy: Starbucks and Chipotle both missed last week, with Del Frisco's reporting a 0.7% drop in same store sales. Earlier today, McDonald dropped after also reporting US sales growth that was half what analysts expected.