Tightening Consumer Spending Eats Away at Restaurants’ Profits (DRI, EAT, MCD, YUM, more)

As part of the fiscal cliff resolution that policymakers set forth on January 1, the payroll tax holiday expired. Now, an extra 2% is taken out of every worker’s paycheck in order to fund Social Security. This 2% reduction in take home pay has caused consumers to reduce spending and cut back on many expenses. Restaurant operators have been among those that have been closely monitoring the current state of consumer spending and how it will impact their bottom lines going forward.

The average American takes home about $19 less each week due to the end of the payroll tax holiday. Though this may not seem like a lot to most, that $19 adds up each week. Most Americans, especially in tough economic times, need that extra cash each week to maintain spending which is a vital part of the overall economy.

Also putting a strain on consumer spending has been the significant rise in gas price so far in the first quarter of 2013. More money that goes toward fueling automobiles, which is an necessary cost for most to get to jobs, means less money to keep up the previous levels of spending.

One of the first areas to take a hit when consumers start scaling back overall spending is the expenses related to dining out. On the surface this may not seem to have much impact on the big picture, but for investors with positions in stocks in the restaurant industry, the implications couldn’t be more dire. On top of overall changes in the industry, some restaurants now have to navigate a new obstacle to help maintain profits, dividend payouts, and rising share prices.

Restaurants to Watch

The restaurants that analysts project to be the most in danger of taking revenue hits is those that cater to low- to middle-income consumers. These include restaurants from Darden Restaurants (DRI) and Brinker International (EAT).

The low- to middle-income customers that tend to frequent these restaurants are those who are most likely to cut back on restaurant spending. It could mean tough times ahead for these companies; investors would be advised to remain on the sidelines when it comes to these potential investments.

Darden Restaurants
Darden is the parent of Oliver Garden, Red Lobster, and Longhorn Steakhouse, among others. Last week the company posted a 18% decline in third quarter profits. The company and its stalwart restaurants have had trouble maintaining a refreshing product for customers in the recent past. Its stale image, plus the hurdle of attracting customers in a time of decreased spending, means that earnings could be strained going forward as well.

Looking ahead to the fourth quarter, analysts are projecting that Darden will earn $1.04 per share versus $1.15 per share a year ago on revenue of $2.26 billion; last year the company posted $2.07 billion in revenue. Though it is expected that sales will be on the rise, they are not rising enough to boost profits substantially.

Brinker International
The forecast for Brinker International, home of Chili’s and Maggiano’s, is more optimistic than Darden’s outlook, but it does not mean the company is in the clear. Analysts are expecting the company to earn 69 cents per share in its third quarter, compared to 60 cents per share earned in the third quarter last year. Revenue is expected to be $742.01 million versus $747.24 million last year.

As can be seen by total revenue estimates, Brinker is expected to take a hit in sales in the current quarter. The company has had to adapt, like Darden, to help offset the growing notion that the restaurants offer a stale product. Both face these similar headwinds going forward.

Restaurants in the Clear

Now, not every restaurant is expected to be negatively impacted by this decline in consumer spending. Specifically, cheaper, fast food options might actually benefit from consumers scaling back expenses. This could mean good things for dividend paying companies like McDonald’s (MCD), Wendy’s (WEN), and Burger King (BKW). However, investors should be warned that this does not mean that these companies do not face other struggles going forward; a shift in consumer spending to cheaper products could just mean a slight uptick in sales.

Burger joints are not the only restaurants that could benefit from a shift in spending. New dividend paying company Domino’s Pizza (DPZ) is also among restaurants that could see a boom from a cutback in more expensive restaurant spending.

Yum! Brands (YUM) is also in the same boat as the fast-food burger and pizza joints mentioned above. An additional benefit of this stock that investors should be aware of, in addition to its attractively priced food product, is that it has exposure to emerging markets that could help drive sales. Even though the company took a hit recently from a poultry scare in China, it seems like its troubles are behind them on that front.

Starbucks (SBUX) is also among quick-service restaurant operators that could navigate a decline in overall consumer spending, but for different reasons not related to a cheap product. Starbucks offers a product that its customers are already willing to pay a premium for; these customers will unlikely be among the consumers consciously trying to save limiting the amount spent on a daily latte.

In the event that consumers do scale away from purchasing Starbucks, the company can fall back on the comfort knowing that its products, in both its retail locations as well as on grocery store shelves, have high margins, meaning profitability can be maintained even if revenues do slip. Many analysts see growth in Starbuck’s stock.

Tax Refunds to the Rescue?

Many analysts, investors, and restaurant insiders are hoping that the tax refunds that will be going out to workers soon will help boosts sales. However, even if tax refunds do help bring in some customers, it will only be a short term solution to a long-term problem.

The Bottom Line

The long-term issues of the economy recovering at a snail’s pace and meager wage growth are what really matter for these investments. Until these long-term issues are resolved, it is likely that restaurant investments like Darden and Brinker will continue to struggle.

Be sure to visit our complete recommended list of the Best Dividend Stocks, as well as a detailed explanation of our ratings system here.

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