Fitch: U.S. restaurant growth sustainable in 2012

by Eric Schroeder
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NEW YORK — U.S. restaurant food and beverage costs are expected to remain a headwind in 2012, rising by 5% or more for a second consecutive year, according to a new report from Fitch Ratings. Despite the higher costs, though, large chain restaurants are well positioned to overcome significant margin erosion through modest same-store sales growth, menu management and heavy reliance on low-cost franchising, Fitch said.

The report, “2012 Outlook: U.S. Restaurants,” was issued Dec. 7, and it includes a look at growth prospects for McDonald’s Corp., Yum! Brands, Inc., Burger King Holdings, Inc., Darden Restaurants, Inc. and DineEquity, Inc.

In its outlook, Fitch forecast U.S. restaurant sales growth at about 2% to 3% in 2012. But the ratings service acknowledged that volatility will be a factor throughout the year.

“Low-single-digit pricing and slightly improved traffic is anticipated,” Fitch said. “Further upside is limited by economic uncertainty, slow job growth, and weak consumer sentiment that will constrain spending on food-away-from-home. Global firms and those opening new units will experience better top-line results. Expanding in China and navigating through fragile European economies will be priorities.”

Restaurants with a high mix of franchised units are expected to be best positioned to withstand rising food costs, Fitch said, while company-operated restaurant margins are forecast to remain under pressure from rising chicken, grain and beef prices.

Overall, Fitch rated about 80% of U.S. restaurants’ outlooks “stable,” with 20% rated “negative.”

Menu strategies will remain key heading into 2012, Fitch said. The ratings service expressed concern that the industry’s focus on demonstrating value and using promotions to drive business may cause consumers to trade down to lower priced less profitable menu items.

“Designing products or creating menus to ensure a certain level of profitability is viewed as critical for the industry,” Fitch said. “Fitch believes McDonald’s tiered menu provides increased flexibility with its pricing. Additional McCafe beverage flavors in 2012 will drive traffic and could also help profitability, because specialty drinks are higher margin and often result in a higher check.”

Additionally, Fitch said that while it initially was concerned about the effect of national menu labeling expected to take effect in 2012 it now believes some consumers will be willing to pay higher prices for healthier low-calorie products that are being introduced.

“These new offerings may be in smaller portion sizes and also carry high margins,” Fitch said. “Examples of healthy alternatives being provided by restaurants include breakfast items like McDonald’s Fruit and Maple Oatmeal and additional lunch and dinner offerings on Applebee’s Under 550 Calories menu.”

Fitch said it expects same-store sales improvement to be sustainable in 2012. In the case of Burger King Corp., Fitch said it anticipates a reversal in the company’s string of same-store sales declines behind changes in the company’s menu offerings and marketing that should broaden consumer appeal. At Yum! Brands, the company’s Kentucky Fried Chicken, Taco Bell and Pizza Hut brands are expected to struggle in 2012, but performance in China and at Yum Restaurants International should compensate for the weakness, Fitch said.

Casual dining steakhouse establishments such as LongHorn Steakhouse and Outback Steakhouse should continue to benefit from their broad appeal and relative value given high retail beef prices, while double-digit same-store sales growth at Red Lobster probably won’t be sustainable, Fitch said.

“Bankruptcies among smaller chains, franchisees, and independents could continue in 2012 due to the prolonged period of weak sales growth and high food costs,” Fitch said. “Areas of weakness include family dining, as this segment has exhibited vulnerability in past years, and franchisees of struggling quick-service brands. Fitch also views an increase in bankruptcy filings by highly levered privately held restaurants as a possibility.”

For the full report, visit www.fitchratings.com.

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