Motley Fool Hidden Gems Investing - Restaurants Play Value Games

Episode Date: October 6, 2024

David Henkes is a Senior Principal for Technomic and a global food and beverage trendwatcher. Henkes joined Ricky Mulvey for a conversation about: - How McDonald’s kicked off the value wars. - Why the price of fast food convergerged with some sit-down meals. - The publicly traded restaurants where customers are flocking. Companies discussed: MCD, EAT, BLMN, TXRH, DRI Host: Ricky Mulvey Guest: David Henkes Producer: Mary Long Engineer: Desireé Jones Learn more about your ad choices. Visit megaphone.fm/adchoices

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Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. And if you look at, you know, beef costs and you look at labor costs and you look at all of the drivers of costs and everything right now in the restaurant industry is going up, right? So margin, you know, I've said this publicly, I've been at Technomic 28 years and it's, I believe, harder today to profitably run a restaurant than it ever has been in my entire career doing this type of work. i'm ricky mulvey and that's david hankis a senior principal for technomic and a global food and beverage trend watcher you may have noticed that restaurants today are trying to offer more value to get you back in the door and some are finding tremendous success that's why chili's parent

company brinker international has seen its stock more than double in just the last year hankis joined me for a conversation about the state of the value wars the winners the losers and some ideas for your next meal out. The value wars at restaurants are in full swing. When you watch a college football game, you're going to see the appeals from restaurants like McDonald's, Dunkin' Donuts, please come back. We'll give you a full meal for five to six bucks. And Dave, I'm even seeing this on the higher end where this Brazilian all-you-can-eat steakhouse, Fogo de Chão, is offering a $39 deal for meat presented on swords, all-you-can-eat minus the expensive cuts. And for the investors listening, this is Peter Lynch style at its tastiest. As we get into the value wars, though, it seems like it's heated up a lot lately, even though restaurants have always been promising a good deal for a meal.

What do you think the starting flare was, though? when did this really start? I think you've got to go back probably six to 12 months to look at overall restaurant industry traffic patterns, because that's really, traffic is the lifeblood of the industry. And if you look at fast food or limited service traffic patterns, they started to decline roughly kind of beginning of the year. They started to decelerate and actually over the last four to five months, traffic patterns for fast food, limited service restaurants have been negative. Now on the full service sit-down side, traffic pattern has been negative for a lot longer. And so what we've seen over the past several years as higher prices, higher menu prices

have continued to hit consumers in the face every time they dine out, is that traffic has really taken a hit as a result, right? So traffic is slowing considerably. And really across the border, across the restaurant industry is negative now, meaning fewer consumers are visiting today than they were a year ago. And so really the best lever, and in some cases, the only lever, given that this is largely driven by pricing, has been to pivot to value. And in this case, value being lower price, although, as I think we'll probably discuss, value is not always price. But McDonald's, probably as the largest restaurant chain in the world, probably led it off with their value meal at the beginning of the summer, and a lot of chains followed suit.

Largely, I would say, and firstly, other fast food chains, but then increasingly full service sit-down chains as well. And so really now we're in a situation where almost everyone is trying to put on some type of value equation, value bundle, value offer onto their menu. And it's really intended for one purpose, and that is to drive traffic, to bring consumers back into the restaurant. And so far, certainly some chains have been successful, but I would say if you still look at the overall industry patterns, the overall industry is still in decline when it comes to visits and traffic. Yeah. Let's talk about McDonald's for a second. It's the largest restaurant chain, as you mentioned. I wonder how much of this was McDonald's trying really hard to

become an app company, where with the McDonald's app, they started offering, and I'm saying this in quotations, free delivery. And on the app, there's a lot of buy one, get one offers. And it seemed to come at the expense of higher menu prices if you're just going through the drive-thru. Yeah, I think every major restaurant chain that has an app, and that's just about every fast food chain, wants to drive orders through their apps. There's a lot of reasons for it. The data they can collect, the loyalty programs. And so the best way to do that is by giving pricing and discounts and deals through the app, right? I mean, to really convert that behavior or to drive that behavior, you've got to give people a reason to go to the app and the lower prices are the

reason why they're doing that. Now, if you think back to the beginning of this year, or maybe it was, you know, more kind of early spring when Wendy's got hit over the head about the variable pricing or the surge pricing, I guess the sort of the media took it as, consumers don't want to pay higher prices, right? And there was a, I guess, I'd call it a rightful backlash against it, even though I think it was probably misconstrued a bit in terms of what Wendy's intended to do. But consumers don't want to feel that they're being taken advantage of and paying a higher price for something that 20 minutes ago would have been a lower price, even though they do it

all the time in hotels and Uber and Lyft and all of those other things. And so I think one of the ways that restaurants are also then able to do dynamic pricing is through the app, right? Because now you're able to give discounts, you're able to target offers to consumers, you're able to look back and use AI or other computer learning to understand what their order pattern is and make offers to them. And then, by the way, you can promote higher margin items as part of the app or as part of the deal. And so you can manage profitability a little bit easier with the app. And so there's a lot of reasons that restaurants want to drive behavior or drive consumers to the app. And that pricing becomes a big reason for it. And so I think there's been a lot of success

for McDonald's in particular, in terms of getting people to, to move to the app and order through that. Um, let's talk about one company that's doing really well in the value wars and that's Brinker international. You're talking about on, on CNBC and actually speaking of driving consumer behavior, it drove me to Chili's to check out their mozzie sticks. Um, but the stock is up 150% over the last 12 months in just the last quarter, Chili's same store sales was, was up 15%. And this is exceptional because a lot of those same store sales happen during peak times or same restaurant sales. So what's happening at Chili's? What's happening at Brinker International? What are they putting in the ribs over there?

Well, Chili's is really one of those that put a big emphasis on marketing themselves against fast food, right? And so, you know, the message in general was, you know, if you want to pay 11 bucks or whatever for a burger and your meal, then why don't you come in here and we'll give you a better product, we'll give you a better experience. And again, the value for that, which is more than just price, is a lot higher. And so they were really one of those that went hard against this perception that fast food has that it's gotten too expensive. And so they've they've certainly built upon it with you know service and you know they've got a leadership that understands the value of uh you know creating that atmosphere and and you know

so you know again value is more than just the price so people are going in there and obviously they're returning and you know when you look at our traffic um uh numbers that we that we track because we in addition to what the chains put out we kind of do some of our own tracking behavior for traffic. And if you look at Chili's over the last, and we do it kind of on a rolling three-month period, but they've been high single digits or low double digits in terms of traffic really over the past, probably since the beginning of the summer. And if you go back to what I just said about traffic in general in the industry being down, That is a phenomenal accomplishment to be able to drive that much incremental growth in traffic to your restaurant in an environment where really nobody is succeeding in doing that very well.

And so for them to be able to do that. And so I think it does speak to the deal that they've developed, that it resonates with consumers, but they obviously have to back it up with, you know, more than just a low price. The product's got to be good. The service has to be good. Uh, and clearly, uh, they've executed on all of those and they're doing really well with that. Oh, Dave, when I went, I was very satisfied. I got, I got my cheeseburger, which is like, it's a, it's a, not a thick cheeseburger, but it's a substantial cheeseburger fries, a side salad diet Coke for 11 bucks. And when they're doing that, I'm like, are they making a profit off this? Or am I just getting real sleepy? well margin always becomes a challenge with this right i mean and so i think there's a little bit of a trade-off in the industry going on right now where listen you know anytime you sell something

for a lower price your margin all things being equal or is going to be less right and so what you're banking on with people coming in there's a couple things one you're banking on them not just getting the deal but maybe then you know uh either bringing in some other people that are going to order some desserts or extra side dishes or appetizers or maybe a beer or some kind of beverage alcohol or something like that, that's going to drive some incremental profit. But there's no question that if you're selling that whole meal for 11 bucks and if you look at beef costs and you look at labor costs and you look at all of the drivers of costs and everything right now in the restaurant industry is going up, right? So margin, you know, I've said this publicly,

I've been at Technomic 28 years, and it's, I believe, harder today to profitably run a restaurant than it ever has been in my entire career doing this type of work. And so, yeah, you are taking as a restaurateur a lower margin to do that, but you're trying to gain traffic, you're trying to then gain a new customer that again, may come back again and build some loyalty to them. And so the, I think the bet, uh, that a lot of restaurant leadership is making is that that lower margin in the short term is, uh, worth, uh, maybe the longer term, uh, it's worth it for the longer term benefits that you're going to accrue because of that. And to be fair with the second part of this. I mean, I got the mozzarella sticks, which are like three for $10 and 30 cents. So I'm

like, okay, that's where all the margin went after you sold me a hamburger and two sides for 11 bucks. My partner got the Chipotle chicken bowl for a little under 15 bucks. So I can see how that, what you're talking about works, you know, come in for the great value, but if you want to get those viral mozzarella sticks, that's what's going to cost you, especially on the appetizer side. Continuing on price though, there's this convergence happening, which is that these sit-down restaurants, these sit-down casual chains are now competitive with quick service restaurants on price. I mean, even looking outside of McDonald's, even a Chipotle meal is 11 bucks and I got to stand and order my food there. How are these sit-down places able to now

compete so meaningfully with the fast food chains and the quick service restaurants? Well, I think there's a couple of things that's happening and you're right. And there was just, It's not technomic data, but there was just some YouGov survey data published just recently that showed that basically of all restaurant types, fast food is seen as having the lowest value perception, which is gobsmacking to me because the whole sort of, I don't want to say rationale for fast food, but fast food has always excelled in value and has been the haven that consumers flee to in tough economic times. for value. So the fact that casual dining now, at least per the YouGov data, outperforms fast food on value is just really amazing. And it goes back, I've seen some other data that a lot of fast food customers now describe fast food as a luxury, right? And so there is a perception. And again, going back to what I was saying earlier about pricing, if you look at and believe the government CPI numbers, and there's no reason not to, you would see that there has been a

growing discrepancy between limited service pricing and full service pricing. And both are going up a lot faster than grocery store pricing. So it's not as though one is significantly cheaper, but the price increases that have been driven by limited service have been higher in aggregate than full service. Now, there's a couple of reasons for that. There's been a lot of upward push on minimum wage. And so a lot of times fast food restaurants have a lot higher share of fast food of minimum wage workers. And particularly in California now, where going back to the first quarter that the minimum wage skyrocketed, menu prices the next day immediately followed suit. Right. And so and and when you're paying a lot of minimum wage people now an extra even just a couple bucks percentage wise, it's got a huge increase.

And and so I think a big part of it has been labor cost increases. And you still have a lot of full service restaurants that are able to, I don't want to say avoid labor challenges or cost issues, but because of them are still working on the tip credit, they're able to offer a lower minimum wage to their servers, especially that then, you know, theoretically gets made up in the tip that those servers earn. And so there's definitely upward pressure on labor and sit-down restaurants, but it's not nearly as pervasive as it is in fast food. So I think that's the biggest thing. And I think when you look at cost increases right now, food costs have generally, you

Last year, we saw PPI, producer price index, for a lot of the foods that are used in restaurants that were soaring high single digits or double digits. And a lot of those cost increases have at least decelerated into normal ranges. It's really still the labor that's driving it. And so the fast food labor situation, I think, is a big reason why the value perception has gotten out of hand. And by the way, that's the reason there's been a lot of tech investment in fast food, right?

Because labor has gotten so expensive now, you know, what they're not doing necessarily is taking a lot of labor out of the restaurant, but they are redeploying it and hopefully, you know, using it more efficiently. So I don't know if I just answered your question or not, but that's really kind of why the value proposition, I think, is getting so out of whack and consumers have noticed based on all the surveys we've seen. And it's really a really interesting phenomenon right now. No, you did answer the question because if you're at a fast food restaurant, you're going to be able to it's a per hour cost. And this is something I notice, uh, I'm not in California, but I see it driving around with, uh, you know, 15, 20 bucks an hour to work at a fast food restaurant. And it's, um, it's a very difficult job. So I imagine why there's, there's a demand for, for higher labor costs there. But if you're at a full service restaurant, when I go to, uh, went to Texas roadhouse last night,

those servers are paid based on, on the tip I'm interested in is with, uh, essentially stakes for for a number of reasons um texas roadhouse stock has done exceptionally well longhorn steakhouse has been a bright spot um for darden restaurants and right now we're at this um another interesting convergence point where you can get a one pound ribeye at texas roadhouse with two legendary sides for 32 bucks and that's before tax and tip but that doesn't feel super far off from grocery stores where a one pound ribeye it's Safeway right now is like 25 bucks. How are you, you mentioned earlier that there's a convergence where they're using that to draw people into, to buy appetizers, to buy, to buy drinks, that kind of thing. How are you seeing

that play out with the traffic data that you, you look at it technomic? Yeah, I think, you know, when I pull my steak restaurants specifically, and I look at, you know, who the winners are right now in in traffic anyway texas roadhouse is by far the winner they've had high you know either mid to high single digit growth in traffic um and a lot of the other at least big chains that we track longhorn is decent they're trending okay but not performing nearly as well as texas roadhouse but then outback's been declining ruth's chris has been declining capital grill has been declining. Logan's, which was really bad last year, has sort of flattened out. And I think that's just because of comparisons to this year. But, you know, so I think when I look at steak

and steak is, you know, beef prices are still really through the roof right now, to your point about grocery. And so I think, you know, the value perception for steak is, you know, first of all, a lot of the the more expensive cuts right the tenderloins porterhouse prime ribs aren't the things that are being promoted right now they tend to be maybe focusing on uh you know some of the other maybe lower cuts and you know you look at like fogo de chow right now with their best of brazil they're doing a lot of brazilian style cuts that maybe aren't the the highest uh priced cuts but they're able to offer a value deal with that right and so you know 39 40 whatever it is But I think when you look at the the steakhouses and what's happening there from a from a value perspective, you know, they are probably taking a lot lower margin than than they want to be.

And I think that, again, goes back to traffic. And especially if you're a publicly traded business, you are reporting not only on your margin and profitability, which given the environment and restaurants, I think every investor probably expects margins to be challenged right now anyway. But if you can tell a positive story from a traffic perspective, that is great news for at least four-year investors or for the CEO to go out on a quarterly call and talk about that. And so I think there are some margin challenges or some margin massaging maybe that is going on. And I think when you look at a lot of the LTOs, and so we look at limited time offers as a sort of a good barometer for what's happening on the menu. And when you talk about sort of in general terms what's been happening on the restaurant menu over the last couple of years, core items are down and LTOs are up. Meaning that restaurants have trimmed back, pared back their core offer, and they're offering a lot more things on a limited time offer. And the reason for that is that they are able to sort of value engineer a lot of those LTOs. Maybe they're, you know, smaller cut steaks. You know, maybe they're filling the plate more with some different starches as opposed to the protein. You know, there's a lot of different ways you can sort of value engineer a plate. But with an LTO, because you're not now promoting a menu item that maybe consumers knew before that they compare to something else, it becomes a new item to the consumer. And so you can price that even if you're more aggressive on the price, you can price it aggressively while still trying to manage your margin a little bit.

And I think that's some of what's been going on as well. You know, and I look back at like a Ruth's Chris and they actually did have an LTO with a filet and they had a glass of rosé that they were doing. They had a filet and Bayou Lobster LTO that they were doing. So they are, you know, also doing that with some of the maybe higher or higher cost items. But again, a lot of that becomes a traffic play to try to get people in the restaurant And, you know, and again, hopefully upsell them and particularly in a steakhouse or a seafood or any type of sit down restaurant, that alcohol sale is is a high margin. And, you know, we've seen alcohol sales really slow significantly, which has also had a big impact on full service chain profitability because that and appetizer and dessert is where all of the margin is often made.

And so if you can bring people in and get them in on, you know, a $39 deal or something like that, and then create all of these other things to have maybe a 50 or $55 check average, you're still in a way, you know, you take dollars to the bank, not margin. And so if you can build up that dollar spend and create some dollar margin on that guest, then it becomes a win for the restaurant. On vacation to Switzerland and Germany, you posted about some of your experiences on X. I know your brain was on vacation mode, but any interesting food or beverage trends during your travels? Well, you know, I was really struck by a couple of things. There's a lot of automation over there. A lot more, you know, not only in the quick service environment, but even vending. And so I was struck by two things. One, the higher degree of technology usage and integration.

But then, frankly, I was quite impressed. And this is, you know, maybe a little weird because I don't think I've really noticed it in the past when I've been here. The service level seemed really good. And I don't know if, you know, because they're paid and going back to sort of the pay and the kind of the financial structure of restaurants that they're paid differently. you'd say, well, they're not working for tips maybe like they are in the States. But I was really struck by the attentive service levels that we receive now. You know, I was in some touristy towns or probably catering more to tourists that are going to, you know, maybe tip a little bit more than the locals are. But I was really struck by that. And, you know, I was struck by some different packaging types, type of things that they do. They have much more stringent packaging regulations than we do in the States, a lot more compostability, a lot more just

environmentally friendly packaging. So it's really interesting. And you never really turn your brain off completely when you travel. And particularly because dining is such a central experience to travel that I am always just at least kind of looking at what is happening. But anyway, those are a couple of the things that struck me. The principal and head of strategic partnerships at Technomic. Thanks for joining us. Appreciate your time, your insight, and I'm going to go eat lunch. Great. I appreciate it. Got a chain restaurant that you love going to? Let us know at PodcastsAtFool.com. That is Podcasts with an S at Fool.com. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations

for or against. So don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.