Biting the Bullet: Q2 Restaurant Earnings Show a Shift in Consumer Appetite

One of the biggest changes in the market over the past 10-15 years is that investors have succeeded solely by buying the best business, not necessarily the best stock. Focusing on fundamentals over quality has been a good way for investors to underperform.

Some observers have criticized that shift as proof that "valuations don't matter anymore". But in fact there are good reasons for that shift – which the restaurant and packaged food spaces both highlight.

With the rise of online advertising in particular, better businesses have many more ways to tell many more consumers that they are better businesses. Technological advances such as cloud computing and industry shifts to outsourced manufacturing have undercut the legacy benefits of scale. Being big simply isn't enough anymore.

A Deeper Dive on Restaurant Earnings

Restaurant earnings for the calendar second quarter in the restaurant space add yet further confirmation of this long-term trend: obviously, the period was not easy for the industry. Inflation has moderated, but the "compounding" effect of multiple years of price increases has pressured consumers particularly on the low end.

In some respects, the biggest recent winners in the restaurant space were those whose business models left them with little exposure to lower-income consumers.

Perhaps the most notable result of restaurant earnings season came from McDonald's, whose same-restaurant sales actually declined 0.7% year-over-year in the U.S. In previous quarters, management had highlighted weak visitation from lower-income customers, and that pressure only increased in Q2. But execution was a factor as well: CEO Chris Kempczinski admitted that his company's longstanding "value leadership gap" against peers had shrunk.

McDonald's responded by returning to its value roots with a $5 bundle; essentially every quick-service peer has since followed suit. Most had little choice: Burger King and Wendy's both posted similarly weak same-restaurant growth. Both rivals told similar stories. Wendy's in fact not only said that its lower-income consumers (under $75,000 in household income) were cutting back, but that its higher-income consumers were increasing visits, perhaps as a result of trading down from the fast casual and casual dining segments.

In fast casual, for the most part the best and most differentiated operators remained the best operators. Chipotle, Sweetgreen, and Shake Shack all gained after earnings, with the latter two posting huge rallies. Sweetgreen stock jumped 33%; Shake Shack an impressive 17%. Both stocks sit near multi-year highs.

El Pollo Loco continues its turnaround, but even its overall margins weakened modestly year-over-year. Its own value offering, a 3 for $9.99 or $8.99 deal, further cements the idea that all but the most established operators in the space simply have to compete on price.

Even for those companies that haven't reported earnings, investors are clearly anticipating more of the same. Cava has bounced back from a market-driven sell-off ahead of its release next week and is nearing its past highs; Red Robin Gourmet Burgers is threatening an all-time low, 22 years after it went public, as investors sour on yet another attempted turnaround.

But even here inflation is raising its head. Chipotle warned of lower margins in coming quarters, in part because of efforts to maintain consistent portion sizes, but also due to higher avocado and dairy prices.

Casual dining remains exceptionally difficult these days, and only the better operators can power through.

Dine Global, the operator of Applebee's, IHOP, and Fuzzy's Taco Shop, is seeing negative same-restaurant sales across the portfolio. Applebee's clearly was outperformed by Brinker International's Chili's, who launched a 3 for $10.99 offering that it marketed as competitive with fast food options.

IHOP didn't perform much better, with comps down 1.4%. Clearly, the breakfast daypart is pressured, with Denny's too posting negative top-line results and even higher-end First Watch posted a 4% decline in same-restaurant traffic. Cracker Barrel is struggling on every front, with inflation pressuring its larger base of fixed-income customers; its stock has been halved so far in 2024, and trades at a 14-year low.

What Do These Restaurant Earnings Mean?

To anyone paying attention, the overall trend in the industry in Q2 was not much of a surprise. Inflation is moderating, but there clearly is a delayed effect of the price increases taken over the last two-plus years. 

The lower-income consumer is wobbling. Between trade-downs in quick-service, and a clear pullback in breakfast, there is some evidence that even customers on a firmer financial footing are shifting toward more in-home consumption.

All told, it's a difficult environment. And if it was risky to own a substandard business before the last few years, it seems downright dangerous now. Food Institute Focus

Cash or Credits? Walmart, McDonald's Explore New Kind of Employee Compensation

Working while attaining a degree can be difficult – especially in the retail and foodservice sectors – but some companies aim to change that. New initiatives at large employers like McDonald's, Walmart, and Amazon aim to make on-the-job experience count toward college credits, according to NPR.

The concept isn't entirely new. High school AP classes and military experience have translated to college credits for years, many universities allow students to test out of course requirements, and corporate training from companies like Google and Microsoft already count toward credits. But in a first for the foodservice and retail industries, Walmart and McDonald's are working with colleges to have their own workplace training earn credits for employees. Food handling and kitchen safety training can translate to insurance; table waiting and order-taking can advance a hospitality degree; management skills can be applied to business coursework.

Offering credits for on-the-job training and experience can attract more talent and, in turn, keep that talent on the job more. Some companies, like McDonald's and Amazon, are seeing this as a talent attraction tactic while acknowledging that much of that talent will take their experience on to other employers. Others, like Walmart, see it as a talent pipeline from their stores to their corporate offices.

Lucas Botzen, HR expert and CEO at Rivermate, sees such initiatives as a boon to employers.

Despite the risk of training the future leaders of competitors, the immediate benefits reaped from having a well-educated and motivated workforce outweigh it. He sees it as a net positive for company culture.

"The employer is literally investing in the workers' futures – a situation which creates a culture of growth and loyalty in an organization."

"By investing in workforce education programs, employers can develop and grow talent from within their own organizations," said Stephen Greet, CEO of BeamJobs.com. "When training costs are partially supported by the involved colleges, it presents a low-risk approach for employers to train their future leaders."

The benefit to workers is mainly in reducing the time and cost of acquiring a higher education degree.

For one Walmart supervisor, Bonnie Boop, her Walmart Academy training ended up saving her the equivalent of two semesters of coursework – which, given her part-time student schedule, meant less late nights studying after work and a bachelor's degree in 2.5 years.

"This can turn into a real game-changing opportunity for workers," Botzen said, claiming it could be "the key to unraveling the barriers to higher education for many," making it "much more accessible and relevant to their careers."

But some are skeptical of such initiatives.

"While it seems advantageous to equate workplace training with college credits, this model might undermine the value of formal education," said Michael Mastin, founder at Bowlake Chinese. "Workers could be disincentivized from pursuing further studies if practical experience is deemed equivalent."

There's also the concern that it may be another vector for employers to underpay their employees. "At the end of the day, it really would be best for employers to simply pay people what they are worth and stop using programs like food stamps and course credit as alternatives to that," said Steven Rothberg, founder of College Recruiter.

"Employers have no issue increasing what they charge customers based on the laws of supply and demand, yet they resist acknowledging the existence of those same laws when it comes to increasing pay."

To roll such strategies out at scale, more work would be needed. A codified system of measuring on-the-job training and performance would help in translating employment skills to transcripts, as would a sincere time commitment from academics to consider thousands of student workers on a case-by-case basis – no small task.

However these specific programs work out, the larger trend points to what many are calling a transition to a "skills-first approach" to higher education, where skills and certificates are weighted the same as credentials and degrees in education and employment. For employers, the benefits are clear: eligible talent pools are widened as more job-specific training is prioritized in higher education.

Efforts would need to be taken to ensure the system wasn't being used to exploit workers or students, such as implementing "a strict cap on the number of credits that can be earned through such programs," said Kyle Haynes, an associate professor at Purdue University.

"Universities would also have to ensure that employers are not offering training that has little or no broader educational value. Students would really suffer if universities implemented this kind of program without lots of preparation and careful oversight."

Employment and higher education in America seem to be at pivotal points. As decision makers at the country's largest companies and educational institutions weigh the costs and benefits of skills-first education, it's worth asking:

What is the purpose of a job, what is the purpose of an education, and should they serve the same ends? Food Institute Focus

Store News:

Wendy's entered the ongoing fast-food wars with its $1 Honey Buddy sandwich. The discount sandwich will be available for a limited time at participating locations, reported RetailWire (July 24). Full Story

Meanwhile, breakfast continues to drive Wendy's sales. But the fast-food chain expects to push more value this year as it loses customers amid concern about high prices, reported Restaurant Business (Aug. 1). Full Story

Wingstop opened a pop-up restaurant in Paris, just in time for the Olympics. The fast-casual chicken chain will debut in Maison de Saveurs and give away free wings, sauces, and seasoned fries to more than 50,000 visitors, reported Restaurant Business (July 24). Full Story

Gotham Restaurant filed for bankruptcy protection. The New York City restaurant was recently a victim to online scammers that cost the restaurant $45,000. The Greenwich Village restaurant was forced to close its doors temporarily, reported Restaurant Business (July 25). Full Story

Yum! Brands will expand the use of Voice AI technology across its Taco Bell drive-thru locations in the U.S., targeting hundreds of stores by the end of 2024. The technology is currently in use at more than 100 U.S. Taco Bell locations. Full Story

Shake Shack's new CEO plans to push drive-thrus and value. In an earnings call, CEO Rob Lynch outlined plans for the burger chain's next phase of growth. He's focused on making the premium fast-casual brand a more frequent choice for consumers at all income levels, reported Restaurant Business (Aug. 1). Full Story

Chili's Grill and Bar has reunited with tabletop tablet supplier Ziosk to use the devices in its more than 1,100 company-owned restaurants. Customers can use the touchscreen tablets to pay their bill without having to wait for a server. The devices also feature games and surveys, which are a key source of customer feedback, reported Restaurant Business (Aug. 2). Full Story

Italian-American restaurant chain Buca di Beppo filed for Chapter 11 bankruptcy protection. The company plans to retain its current locations despite challenges related to a sales drop, rising costs and staffing challenges, reported Reuters (Aug. 5). Full Story

Noodles & Company could close up to 20 underperforming restaurants. As the fast-casual chain's turnaround effort unfolds, CEO Drew Madsen said a portfolio review could result in some units being shuttered to focus on those better positioned for success, reported Restaurant Business (Aug. 7). Full Story

Crave Hot Dogs & BBQ is planning to open a new express variation—its first—in a Walmart near Louisville, Kentucky, reported Restaurant Business (Aug. 8). Full Story

Subway plans to give digital customers deep discounts on the company's Footlong subs starting later this month as part of a plan to counter steep sales declines. The company alerted operators at a scheduled webinar Thursday that it plans to offer digital customers $6.99 Footlong subs for two weeks starting on Aug. 26, reported Restaurant Business (Aug. 15). Full Story

5 Supply Chain Concerns to Watch in Late 2024

For months now, Sam Ballas has kept a close eye on growing geopolitical tensions, particularly the Russia-Ukraine war. Even though he's a business leader who resides more than 5,000 miles away in America, Balles knows such conflicts can – and often do – have a far-reaching impact.

"The conflict's persistence could further disrupt supply chains and lead to pricing volatility, particularly for essential commodities like grains," said Ballas, the CEO of North Carolina-based East Coast Wings + Grill.

Several global supply chain issues warrant close attention in the second half of 2024.

Geopolitical Instability: Prolonged tensions in the Middle East – especially the Israel-Palestine conflict – could lead to more oil volatility, Ballas said. Elevated oil prices not only affect transportation costs but also contribute to higher inflation, impacting both businesses and consumers.

Military conflicts, Ballas noted, can disrupt supply chains, leading to delays and increased costs. "These geopolitical tensions can affect everything from raw materials to finished goods," the CEO said.

Consumer Behavior: Continued inflation has tempered consumer spending of late. And, as consumers tighten their budgets, retail and foodservice strategies will need to adapt, potentially leading to changes in inventory management and overall market dynamics.

Transportation and Logistics: Conflicts, particularly in key shipping regions like the Red Sea, have caused significant delays and rerouting of shipments this year.

"Inflated costs of transport and consequential production disruptions (due to shipping delays and supply shortages) prompted by the Red Sea shipping crisis (or the) Middle East crisis will continue to pose challenges for the industry this year," Jena Santoro, senior manager of intelligence solutions at Everstream Analytics, recently told FI.

Additionally, recent discussions around tariffs have tightened the container market, complicating imports into the U.S. and potentially leading to further delays and cost increases, Ballas added.

Trade Policies: The potential for increased tariffs, particularly following the expiration of the Tax Cuts and Jobs Act in, looms large. Recent tariff increases on China by President Biden's administration and the potential for retaliatory measures could escalate trade tensions. Such tariffs, of course, can lead to higher prices for imported goods, further inflation, and disrupted global supply chains.

Severe Weather: Environmental factors continue to play a key role in supply chain disruptions. Last year's drought in the Panama Canal region, for instance, reduced the volume of goods passing through that critical route. Similarly, droughts have impacted cattle markets, and the subsequent recovery could be lengthy.

The biggest global supply chain issue for the second half of 2024 will likely be related to extreme weather, according to Santoro.

"The Atlantic hurricane season is off to a destructive start with Hurricane Beryl, and weather forecasters predict an ... active season with numerous severe events expected to impact the southeastern U.S., the Gulf of Mexico, the Caribbean, and South America," she said. "Supply disruptions to citrus, produce, coffee, and sugar are possible."

"These weather-related disruptions can have cascading effects," Ballas said. Food Institute Focus

June's Restaurant Results Showcase Economic Challenges

Comparable sales slipped 0.1% at the nation's restaurants in June as comparable traffic dipped 2.8%, according to Black Box Intelligence.

June as the first month since February to experience negative year-over-year sales, and was also the second consecutive month of declining sales performance.

"The Consumer Price Index (CPI) rose 3% year over year in June, which was less than anticipated. And prices fell 0.1% from May to June, the first meaningful monthly decline since the early days of the pandemic.

However, most people don't feel positive when they look at prices. A consumer's psychology doesn't consider monthly or yearly growth rates but rather how expensive everything got in just a few years," wrote the group in a report.

Blackbox noted restaurant-goers are responding to current economic conditions by chasing value.

"Typically, for full service restaurants, food and service scores are what separates successful and struggling restaurants, while food and value matter equally for Limited Service.

However, in 2024, value has become far and away the prime differentiator for driving traffic in both of these industry segments." Full Story

Selected Results:

Chipotle Mexican Grill topped comparable sales estimates with an 11.1% gain in the second quarter. Placer.ai reported foot traffic was up about 17% during the quarter, outperforming the wider restaurant space which only saw 0.63% growth, reported Reuters (July 24). Full Story

Starbucks delivered results that were in line with expectations, assuaging investors who had been bracing for another meltdown after being blindsided by the previous quarter's slump. Sales at coffee shops open at least a year fell 3% in the company's fiscal third quarter, the second straight drop, reported Bloomberg (July 30). Full Story

Shake Shack said same-store sales rose 4% in the latest quarter, beating projections for a 3.3% increase. The company said it reduced average wait times and improved order accuracy, reported Reuters (Aug. 1). Full Story

Brinker International said comparable restaurant sales increased 13.5% in the past quarter, with Chili's showing an increase of 14.8%. Full Story

Yum! Brands Inc. posted weaker-than-anticipated sales in the second quarter, mirroring trends at major competitors as consumers worldwide cut back on fast food. Deeper-than-expected declines at KFC and Pizza Hut drove the slump, more than offsetting growth at Taco Bell, reported Bloomberg (Aug. 2). Full Story

Restaurant Brands International beat expectations for second-quarter revenue as it benefited from an overhaul at its Burger King chain and steady demand at Tim Hortons units. The company also completed the acquisition of its largest U.S. franchisee Carrols Restaurant Group, reported Reuters (Aug. 8). Full Story