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The best restaurant stocks enduring through inflation

Consumers are becoming increasingly cost-conscious amid inflation persisting through early 2024. Stephens Research Analyst Jim Salera joins Market Domination to discuss which restaurant stocks are best positioned to navigate the challenging environment.

Salera finds that at the higher end of the consumer spectrum, spending patterns are "pushing forward" amid inflationary pressures, with little change in consumer behavior. However, for consumers at the lower end of the spectrum, he observes that they are being "much more deliberate" about their spending.

For investors evaluating restaurant stocks, Salera emphasizes the importance of identifying "which restaurants are differentiated from the crowd." He highlights names like Chipotle (CMG) and Wingstop (WING), which have demonstrated "very strong traffic trends," as examples of differentiated offerings.

With the risk of consumers potentially "trading out" for better value options, Salera stresses that "it's very important [for restaurants] to have a unique value proposition that the consumer can really identify with to retain that traffic."

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For more expert insight and the latest market action, click here to watch this full episode of Market Domination.

This post was written by Angel Smith

Video transcript

MADISON MILLS: So here with more on how restaurants are set up against sticky inflation, we're going to speak with Stevens Research Analyst Jim Salera. And Jim, thank you so much for joining us. I want to talk about this inflation backdrop that we've been speaking about, it feels like, for years now. But I'm curious how investors should best be positioning themselves going into earnings, specifically in the restaurant space given that macroeconomic backdrop here.

JIM SALERA: Yeah, great. Thanks for having me on. And Maddy, I think you actually brought up a really good point as we came into this segment, which is this bifurcation in consumer spending.

So at the higher end, you really see consumers pushing forward and not changing much of their behavior. But at the lower end, the consumer is being much more deliberate with their purchase. And so for restaurants, I think that means you really need to look at which restaurants are differentiated from the crowd.

Yeah, you mentioned Chipotle. Wingstop is another one that is seeing very strong traffic trends. And so, I think as investors try to slice and dice who's better positioned, you really have to start with who has a differentiated offering compared to the group as a whole.

JULIE HYMAN: Jim, it's Julie here. I'm also curious, you mentioned two names, you know, that I guess are not QSR, or QSRs. Quick service restaurants. And I wonder, is it sort of going to be restaurant by restaurant, or can we also think about quick service versus a fast casual Chipotle in that category? Are we going to see people migrating to lower cost offerings, or is it more that the folks who are the core customers there are just going to be spending less?

JIM SALERA: Yeah. So I think if you look-- it is important to look brand by brand because you are going to have some, you know, like I mentioned Wingstop that have very healthy traffic trends relative to peers. I think if you look at the value names, you know, McDonald's QSR, which has Burger King, and then Wendy's, they appeal to a lower-end consumer.

However, the risk that you run when the consumer is in a pressured position is something we call trade out, which if you think about the value ladder, you trade from a more expensive to a less expensive option. But you also run the risk of just buying more food at the grocery store. And so, think about that as, like, you pack your lunch instead of going out to eat for lunch, or you skip breakfast. And so, when we have this bifurcated consumer environment, I think it's important to understand the risk that the consumer could trade out at the lower end if they feel really pressured.

MADISON MILLS: And just to put a button on that, Jim, what are some of the names that are at the most risk of that trading out dynamic that you're describing?

JIM SALERA: Yeah. So I think if you look, you know, on our list, obviously Wendy's for fast food offering. Some of the ones we don't cover, like McDonald's, also have a focus that's more oriented towards your core kind of fast food down the fairway offering versus-- you know, Chipotle. That's much more differentiated, and also targets a higher consumer.

And Chipotle has even said, you know, they have seen growth across all income cohorts. So again, tying back to that differentiated offering. I think it's very important to have kind of a unique value proposition that the consumer can really identify with to retain that traffic.

JULIE HYMAN: Well-- and Jim, it's interesting because Chipotle is an example of a restaurant that has continued to raise prices. Costs for restaurants are rising, whether you're talking about ingredient costs, fuel costs, labor costs, right? Are we going to see-- where else are we going to see potentially pricing power?

JIM SALERA: Yeah. So I think-- you bring up a really interesting point. And this ties into some of the ways that restaurants have to sharpen their price points.

So a unique dynamic that's going on right now that really hasn't existed in the past is the much more widespread availability of restaurant apps and rewards programs. And so, in the past, you might have had, like, a value menu ring offering or, like, a national ad that says, you know, you buy one burger, you get one half price. I think what you're going to see now is restaurants leaning into their consumer data and leaning into their apps, and really offering targeted promotions that can help keep the price point sharp without having to just blow up a promo across their entire menu.

And so, for example, if you think of kind of a normal fast food concept, if you like cheeseburgers, they see you haven't been to the restaurant in the last month, maybe they push you an offer on the app that says, if you come and buy in burger, we'll give you a free fry or we'll give you a free drink. And that's something that really hasn't existed before. And so, I think it allows them to be much more deliberate on pricing and much more focused on promotion so that they're still conveying value to the consumer without having it be, you know, kind of broad and less targeted across the whole menu.

JULIE HYMAN: Gotcha. Jim, thanks so much for your insight. Appreciate it.

JIM SALERA: Yes, thanks. Thanks for having me on.