Has 2016 Brought a Restaurant Recession?

Recently there has been increasing chatter concerning a “Restaurant Recession”. This follows a number of negative indicators, including:

A 1.5% — 2% decline in same-store restaurant comparables across all categories in Q2 2016 (Stifel Financial).
Sales declines in 3 of the last 6 months through July, as reported by U.S. News Magazine.
Declining sales at fast-casual restaurants for the first time since 2004, according to NPD.

Creative Explanations

Explanations for these developments often range from the implausible to the slightly zany. Industry analysts and restaurant CEO’s have blamed declining same-store sales on:

• U.S. Politics and the Presidential Election
• Fears of Terrorism
• Social Unrest
• Global Geopolitics
• Economic Uncertainty
• Rising gas prices
• Brexit (Britain’s Exit from the European Union)
• The Democratic & Republican Conventions, and finally…
• The Olympics

Increasing Competition. Falling Grocery Prices

More likely are two more straightforward factors. Namely, increasing competition and falling grocery prices. An influx of capital from 2010 to 2016 drove the growth of a number of chains such as Shake Shack, Zoe’s Kitchen, and El Pollo Loco. Meanwhile, many new independents have opened in a number of metro areas. At the same time, grocery stores have stepped up efforts to sell ready-to-eat meals, which have increased in their ubiquity, quality, and variety.

Meanwhile, falling grocery prices have become a major factor. According to the Wall Street Journal, 2016 has witnessed the largest decline in grocery prices in the past 50 years, excluding a decline in 2009 & 2010 following the Great Recession. Through May grocery prices were down in 5 of the preceding 7 months. Through July grocery prices were down by -1.6% YTD, according to the Bureau of Labor Statistics, while wholesale food prices were down by -3.7%. Except for increasing prices for fruits and vegetables, caused by the California Drought, in many categories grocery prices are down by -2–5%, driven by excess supplies. Ground beef prices have declined by -12% and Milk by -11%. Eggs have decreased in price by an astounding -40%.

Other drivers for falling grocery prices include lower energy prices for transportation and refrigeration, and falling exports to China, resulting from a slowing economy there combined with the stronger US Dollar.

Analysts believe these declines in grocery prices may continue through the end of 2016, and may exceed the 9-month record for falling food prices observed in 2009 and 2010.

Gap between Grocery and Restaurant Prices

At the same time, a tightening job market seems to be driving labor cost increases for restaurants, resulting in an increase in menu prices, up by +2.8% YTD in 2016. Coming at the same time as declining grocery prices, the result has been the widest gap between restaurant and grocery prices since the 1980s.

A Protracted Slump for Restaurants?

Comparable sales declines in the -2–3% range, observed in 2000, 2007 and now in 2016, have often preceded slumps as long as 2 years for the restaurant industry. Some observers view the restaurant industry as the “Canary in a Coal Mine”. An early indicator of a wider U.S. Recession to come, since restaurant sales are one of the earliest and quickest ways for consumers to cut back on spending. The theory being that restaurant sales decline in the year before a recession and extend to the year after.

If industry pundits are correct, the pain witnessed in 2016 could be just the beginning of a protracted slump. This may precede an industry shakeout that sees weaker players fall by the wayside. Creative measures will be necessary for those that wish to emerge as stronger players for the long-term.