Restaurant stocks have been on the defensive over the past 2 months, and while the erosion in the S&P 500 Restaurant Industry Index is clear, the reason why is less so. Data showing a deterioration in consumer sentiment (University of Michigan, Conference Board) and a slowing in consumer spending is most likely the leading culprit.
But there’s another reason consumers might be turning away from quick service restaurants, or QSR, as price wars intensify among the heavy-hitters after social media backlash on portion reductions and significant price increases.
“Heading into Q2 earnings, we believe sentiment for restaurants is the poorest since GLP-1 concerns gripped the industry late last summer,” BTIG’s Peter Saleh said in his research report, adding that, the weakness is warranted this time “as the price wars are intensifying amidst significant social media backlash.”
The backlash began last fall when Starbucks (SBUX) faced a backlash tied to the Oct 7 attack by Hamas on Israel, followed by accusations of price gouging by McDonald’s (NYSE:MCD), and inconsistent portions at Chipotle (CMG). “Clearly, consumers are disgruntled by the value proposition across the industry and are pushing back,” Saleh says.
This erosion of the “value proposition” which gave QSR its competitive advantage over fast casual suggests a “deep and prolonged price war” among not just QSR, but also with casual dining and fast casual.
After McDonald’s (MCD) introduced its $5 Meal deal last month, the promotion was matched by burger rivals Wendy’s (WEN) and Burger King (QSR). The value meal was in response to criticism leveled against McDonald’s (MCD) for raising its prices 40% over the last 5 years, double most of its competitors. In the long term, however, Saleh thinks these promotions and discounts will adversely impact profitability while the industry waits for traffic to improve.
Unfortunately for QSR, cost sensitivity is exacerbated by minimum wage laws that dictate how much the majority of their employees are paid. Without raising prices to offset higher labor costs, profitability will continue to be undermined.
Next week is when the rubber meets the road as Chipotle (CMG) kicks off Q2 earnings season for the restaurant sector, reporting next Wednesday after the close. Analysts are broadly expecting an underwhelming turnout, as lingering concerns about the state of the U.S. consumer are exacerbated by new headwinds from deteriorating consumer confidence and the political landscape. Industry data from Baird shows that fast-casual comparable sales were up just 1% year-over-year in the first week of July versus a gain of 3% the week prior.
That could potentially translate into a miss on Q2 results for McDonald’s (MCD), Burger King (QSR), Wendy’s (WEN), Starbucks (SBUX), KFC (YUM) and Papa Johns (PZZA). Investors have already seen what faces the restaurant landscape after Domino’s (DPZ) shares cratered on missed Q2 revenue and are bracing for the other shoe to fall.
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