Report: Restaurant costs will continue to rise in 2012

Dec. 11, 2011

Fitch Ratings, a global market credit opinion, research and data agency, expects U.S. restaurant food and beverage costs to rise by 5 percent or more in 2012, and increase for the second year in a row.

Larger chains, however, are in a good position to avoid significant margin erosion through modest same-store sales growth, menu management and heavy reliance on low-cost franchising, according to a release.

Fitch predicts food inflation pressure to be driven in particular by rising protein prices. The latest USDA commodity price forecast calls for 2012 beef and chicken prices to increase by 9 percent and 5 percent, respectively, following a year of double-digit price increases for many food items in 2011.

Although food inflation will hit U.S. restaurant margins again in 2012, labor cost pressure will remain in check as persistently high unemployment and productivity gains limit wage inflation.

Fitch's report said global operators such as McDonald's and Yum! Brands will experience cost pressure through both higher food costs and wage inflation in the rapidly growing Chinese market. Growth in China accounts for a large share of global operating costs because these units are mainly company-operated.

Franchise models will navigate costs better

In addition to modest low-single digit pricing, the ability of restaurant operators to manage cost inflation depends greatly on an operating model that pushes more cost-risk onto franchise operators. Franchised restaurants provide a more reliable source of operating cash flow and higher margins than company-operated restaurants since the franchisor does not cover food, labor, or other operating expenses.

According to Fitch, the benefits of a franchise-oriented model have been clear this year at McDonald's (approximately 81 percent franchised), where consolidated EBITDA margins have remained stable at 36 percent, despite approximately 80 basis points of margin pressure at company-owned restaurants over the first three quarters of 2011.

Minimum wage increases in China have exceeded 15 percent this year as a result of the rising cost of living and tight labor markets. While inflation in China will likely affect margin expansion in 2012, Fitch expects the trend to moderate as monetary policy is tightened. This view is supported by Yum's recent indication that it does not see 2012 Chinese labor inflation reaching the 20 percent rate witnessed during the second half of this year.

U.S. same-store sales growth is expected to average 2 percent to 3 percent in 2012. Sales growth for limited-service restaurants will likely outpace that of the full-service segment again next year as consumers continue to look for value. Even for globally diversified McDonald's and Yum!, weak consumer confidence and lagging economic growth will likely limit global same-store sales growth to the mid-single digits.

As a result of relatively stable consolidated margins and consistent operating cash flow generation, Fitch analysis does not expect significant changes in the credit profiles of major U.S. restaurant operators in the coming year. Global economic uncertainty and ongoing cost pressures will likely limit margin growth across the industry, but credit risk should remain contained.

For a more detailed analysis of these issues, see Fitch's "2012 Outlook: U.S. Restaurants," online.

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Topics: Equipment & Supplies , Financial Management , Food & Beverage , Operations Management

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