Fast-food outlook: Big competition, margin pressures

MarketWatch

NEW YORK — Though the fast-food giants have been holding up better than many other industries — and certainly better than any in the restaurant sector — even they are beginning to suffer from the downturn.

And if the economy, especially with some new jobs, doesn’t start coming back soon, that pressure is apt to continue this year and possibly beyond.

Consider McDonald’s: In late 2009, it posted some of it first U.S. same-store sales declines in years for October and November. The Golden Arches had until then been firing on all cylinders for years, using new products, value menus and expanded hours to lure in diners looking to “trade down” from pricier fare.

The trouble appeared even earlier for some rivals. Yum Brands, parent of Taco Bell, Pizza Hut and KFC, posted a 6 percent decline in same-store sales in the third quarter while Burger King Holdings reported a nearly 3 percent drop in the same key industry metric. Wendy’s/Arby’s numbers also slowed.

Fast-food chains “have been holding up relatively well, as long as you say ‘relatively,’” said Dennis Lombardi, executive vice-president at WD Partners, a consultancy. “They didn’t really feel the pinch until the middle of the year, while other restaurants did in 2008.”

He noted that the category has “some of the lowest price points and a high value perception [but is] not absolutely resilient, nor immune” to economic conditions.

One thing that has been hurting the top and bottom lines is an orgy of deep discounting and couponing. There is almost a “how low can you go” kind of contest going on when it comes to items such as double cheeseburgers and snack wraps.

That has moved traffic levels higher in some cases, Lombardi said, “but the same can’t be said for-profit margins. Some people say this is a “penny-profit” business but [now] it is a tenth-of-a-penny-profit business. But it is certainly better than not having the cash register ring.”

On the plus side, profits have been holding up better than sales, largely due to the help of a weak dollar, which helps international operations and the impact of lower commodity prices as worldwide demand for everything from potatoes to cheese slows. Labor costs are also down with the current buyers’ market for jobs while all of the big chains have been busily streamlining operations and squeezing their vendors.

Operators are reporting declining traffic as consumers dine out less or eat at home while competition “is expected to remain fierce with respect to price, service, location and concept in order to drive traffic, which may adversely affect ... restaurant operating margins and profits.”

Still, with the exception of Wendy’s/Arby’s, Wall Street is expecting higher 2009 profits for the big four, with earnings for all then continuing to grow through 2011, according to analyst estimates compiled by FactSet Research. That could change when the companies begin rolling out fourth quarter and full year numbers over the next few weeks and start to give outlooks for 2010 and/or beyond.

Much will, of course, depend on how long the economy remains in the doldrums and a shifting competitive picture.

According to a new study from consulting and research firm Technomic, consumer perception of fast food has expanded beyond the traditional burger joint to locations that serve up the chow quickly but put more emphasis on “flavor, quality and ambiance.”

Indeed, 41 percent of the eating public apparently now consider places offering “fast food” to include fast-casual restaurants such as Panera and even full-service restaurants that offer carryout or curbside service.

In the bigger picture, Technomic reports that 49 percent of consumers say they eat at fast-food restaurants at least once a week with one in four have increased their visits over the last year, higher than in any other industry segment.

However, even with the new challenges outlined by Technomic, the chains’ worst enemies are — and will likely continue to be — each other.