Technomic: Mixed economic view could dampen spending

Recent economic indicators give a mixed picture of how robustly the U.S. is recovering from the Great Recession, leading forecasters to predict muted growth in the restaurant industry during next two years, with the fast-casual segment most likely to lead the way.

The U.S. Department of Commerce released a revised estimate of the nation’s first-quarter gross domestic product last Wednesday, reporting a growth rate of only 1.8 percent, compared with an earlier estimate of 2.4 percent. The news followed a report from last Tuesday that found new-home sales rose 2.1 percent in May, its highest level since July 2008, implying some welcome strengthening of the housing sector.

That same day, the Conference Board released its Consumer Confidence Index, revealing that the index rose more than 7 points to a score of 81.4 in June, its highest level since January 2008. While that score is markedly higher than 58.4 in January 2013, it still is well below pre-recession levels.

Despite the unclear picture of the economy, Chicago-based market research firm Technomic Inc. is projecting modest sales growth in the restaurant industry for 2013 and 2014, which would trail more robust numbers from 2012, president Ron Paul said.

“Of all the retail segments, there’s no substitute for a meal prepared away from home, so our continued outlook for the industry is still very healthy,” he said. “We’ll shift between brands, but overall, the dollars going to away-from-home eating I can only see increasing.”

At its Restaurants 2013 Trends and Directions conference last week, Technomic forecast that sales in 2013 for limited-service restaurants — which the firm said includes quick-service and fast-casual brands — would rise 4 percent, or 1 percent in inflation-adjusted “real” terms. The firm’s early assessment of 2014 sales calls for a 4-percent nominal gain and a 1.5-percent real gain for limited-service restaurants.

Technomic also forecast that sales at full-service restaurants are not expected to grow meaningfully this year or next year.

In 2012, sales grew 13.2 percent for fast-casual restaurants, 4.6 percent for quick-service brands and 3.6 percent for casual-dining chains.

Paul predicted that the fast-casual segment would remain the key driver of restaurant sales growth over the next few years. He based that notion on consumers in all socioeconomic groups facing different financial challenges and either trading down from casual dining or up from quick service.

“The ‘fast’ is faster than casual dining, and the ‘casual’ means better food quality,” Paul said. “It isn’t just the price that’s different, it’s also the perception of better-quality food, in a different service style with no tipping.”

Who's hurting most?

Fast-casual brands’ supposed sweet spot of service and price points would likely appeal to many people who “are tired of cutting back,” Paul said.

However, recent contradictory economic indicators and uncertainty in the policy arena might still force some consumers to pull back their spending at some point, said Dr. Arjun Chakravarti, who gave the keynote economic forecast at Technomic’s Trends and Directions event.

The picture is more nuanced for middle-class households, said Chakravarti, professor at the Illinois Institute of Technology’s Stuart School of Business. Their job growth is stabilizing slowly and home values are starting to pick back up, but younger consumers in the middle class may be missing out.

“While most middle-class consumers have much better job stability, they do seem to be spending, and those with homes are getting value back in their net worth,” he said. “But some can’t get into the housing market because of student loans and other non-revolving debt, and can’t buy into higher-end purchases.”

There is some possibility for those young consumers splurging on the “affordable luxuries” that Technomic’s Paul said abound in the fast-casual segment or individual chains like Starbucks, according to Chakravarti. But that group is trending toward the frugality of its grandparents’ generation, he added.

Older Americans tend to be represented more in the nation’s wealthier households, who have enjoyed historically low borrowing rates and a nice run in the stock market the past few years — though stocks may be going through a correction, Chakravarti noted.

“If you’re on the wealthy side, it’s tricky,” he said. “If stocks dip a bit and they pull back, those people will put a little more allocation toward savings than they did before.” However, a resurgence in business activity could be behind the improving performance of higher-end restaurants, “like the Capital Grilles of the world,” he added.

Low-income consumers, who tend to have the least amount of education and thus the highest levels of unemployment, are struggling mightily on most economic measures, he said. As with middle-class consumers, the combination of higher payroll taxes and higher gas prices in 2013 severely cut into poorer American’s spending power. But those consumers have it even harder because their employment generally comes from manufacturing and the retail and service industries, which depend on consumer spending.

Effects on the industry

Because economic pressure will likely lead to small increases in spending for all consumer groups, competition for traffic will remain front and center, Technomic’s Paul said, especially among quick-service and traditional casual-dining chains.

“It really is a share game at this time,” Paul said, “because the total pie isn’t growing, but you have to grab your share. If there’s this slowdown in unit growth, it’s hard to keep growing in the U.S. with all these little guys nipping at your sales. Five Guys won’t do the average volume of McDonald’s, but their sales come at somebody else’s expense.”

During their most recent earnings calls, executives at McDonald’s and Darden Restaurants explicitly noted that marketing and menu development would focus on value to drive traffic, even at the expense of restaurant-level margins. First-quarter same-store sales for McDonald’s fell 1.2 percent in the United States, while Darden’s fourth-quarter comparable sales increased modestly at Olive Garden, Red Lobster and LongHorn Steakhouse.

Fast-casual bellwethers like Panera Bread and Chipotle increased same-store sales in their most recent quarters as well, as did Starbucks Coffee. Paul said that those increases likely resulted from customers’ view of those brands as more upscale.

The “polished-casual” segment should also see some better growth, Paul said, citing the Cheesecake Factory, whose first-quarter same-store sales rose 1.6 percent despite slightly negative traffic. But competition in the bar-and-grill segment would likely weigh down casual dining as a whole, he added.

“The traditional casual-dining players like Chili’s and Applebee’s are still stuck with a model that consumers think is kind of dated,” Paul said. “It’s almost becoming the family-dining segment of the decade, where those concepts have flipped into the not-cool places to go anymore.”