Casual chains take hit from higher payroll tax

Restaurants are reeling from their worst three months since 2010, as American diners spooked by higher payroll taxes cut back on eating out.

Sales at casual-dining establishments fell 5.4 percent last month, after declining 0.6 percent in January and 1.6 percent in December, according to the Knapp-Track Index of monthly restaurant sales. This was the first three months of consecutive declines in almost three years, with consumers caught in a “very emotional moment,” said Malcolm Knapp, a New York-based consultant who created the index and has monitored the industry since 1970.

“February was pretty ugly” for many chains -- and probably will be the worst month of the year -- after January delivered an “initial blow” while Americans grappled with increased payroll taxes and health-care premiums, rising gasoline prices and budget debates in Washington, Knapp said. “It’s important to keep in mind that companies also are facing unusually tough comparable sales because of favorable weather in 2012,” so the result is an industry that’s been “a lot softer so far this year.”

Even as consumers open their wallets for bigger-ticket purchases including cars and furniture, weakness has surfaced at full-service companies such as Brinker International Inc (EAT). and Darden Restaurants Inc (DRI)., as well as limited-service chains including McDonald’s Corp. (MCD) and Yum! Brands Inc (YUM).

Shrinking Paychecks

U.S. paychecks have shrunk this year after Congress and President Barack Obama let the tax that funds Social Security benefits revert to 6.2 percent from 4.2 percent. Meanwhile, the average price of a gallon of regular unleaded has risen about 12 percent since Dec. 31, to $3.69 (3AGSREG), including a one-week jump of 17 cents between Jan. 27 and Feb. 3, based on data from Heathrow, Florida-based AAA, the largest U.S. motoring organization.

“That one-week spike was a killer; it destroyed sales in the first week of February,” Knapp said.

All this has “put meaningful pressure on the discretionary purchasing power” of Darden’s customers, causing the company to pre-announce a decline in same-restaurant sales for Olive Garden, Red Lobster and LongHorn Steakhouse in the three months ended Feb. 24 compared with a year earlier, Chief Executive Officer Clarence Otis said in a Feb. 22 statement. The Orlando- based company is scheduled to report fiscal third quarter earnings on March 22.

Index Underperforming

Brinker, Bloomin’ Brands Inc (BLMN)., DineEquity Inc (DIN)., Bob Evans Farms Inc (BOBE). and BJ’s Restaurants Inc (BJRI). -- members of the Bloomberg U.S. Full-Service Restaurant Index -- also have cited these headwinds. The index, which includes 21 companies, has underperformed the Standard & Poor’s 500 Index by 8.2 percentage points since May 29.

Consumers and industry contacts in surveys conducted this month by RBC Capital Markets said higher payroll taxes have been the biggest impediment to sales this year, hurting business for about 63 percent of companies, up from 36 percent last month. Meanwhile, 54 percent of Americans said they already cut back on dining out or intend to do so, the No. 1 reduced expense, followed by clothing and vacations.

“People are acting fearfully, or you could almost say rationally in a way,” because it’s not surprising they change their dining habits when they feel less confident, said Larry Miller, an analyst in Atlanta with RBC. The difference of five guests a day could move a restaurant’s traffic counts by 1 percentage point because the business is “very sensitive to marginal changes.” Sales Prospects

Casual dining is “definitely being squeezed” because “it’s not food on-the-go and it’s not high-end food for people trying to treat themselves,” said Matthew Beesley, who helps oversee $3 billion of assets as head of global equities at Henderson Global Investors Holdings Ltd. in London. That’s making many investors wary about sales prospects for companies such as Darden, he said.

“It seems to me Darden is caught between those two buckets of expenditures,” Beesley said. A sit-down meal away from home is “extremely discretionary,” while there’s also an excess of supply.

With more pressure from other types of restaurants, “casual dining is not necessarily the bright shiny star that it used to be,” Wyman Roberts, chief executive officer of Dallas- based Brinker, owner of Chili’s, said Feb. 27 at an analyst meeting.

Three-Year Low

Although casual-dining sales took the biggest hit in February -- down 4.9 percent -- the weakness was broader, according to “channel checks” conducted by RBC. Fast-food fell 0.1 percent, the worst in two years; revenue growth at so-called fast-casual eateries, up 0.6 percent, was the lowest in three years, the data show.

The environment still is “very, very tough” for Yum! Brands, operator of Taco Bell and KFC, said Chief Executive Officer David Novak. The Louisville, Kentucky-based company is bracing for “a tentative consumer, a tentative economy,” which probably will lead to a difficult year, he said March 13 at a conference hosted by Bank of America Merrill Lynch.

Even so, there is some optimism as “March started on a decent tone,” Knapp said. Similarly, some of Miller’s contacts point to encouraging signs: A delay in tax-refund checks -- which may have contributed to weakness in January and February - - could prove temporary, comparisons may become easier in the next few months and there were “really solid” job gains in February, he said.

Adding Jobs

U.S. employers added 236,000 workers to payrolls last month -- the most since November -- as the jobless rate fell to 7.7 percent, the lowest since December 2008, based on data from the Labor Department.

In addition, Americans aren’t cutting back equally on where they eat out. Sales have varied based on the type of food offered, with steakhouses showing more strength, Miller and Knapp agreed.

As restaurants try to appeal to “pinched and squeezed” consumers, providing value is important for companies like DineEquity, the Glendale, California-based operator of Applebee’s and IHOP, according to Chief Executive Officer Julia Stewart.

“I still think the economic environment is lumpy and bumpy,” she said March 8 at a conference hosted by JPMorgan Chase & Co.