Quantum Pranx

ECONOMICS AND ESOTERICA FOR A NEW PARADIGM

The first casualty of an “improving” economy: The fast food dollar menu, as McDonalds considers hiking prices

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by Tyler Durden
Posted originally Dec 22, 2010

AS THE FALLACY THAT AN ECONOMY IS IMPROVING IF THE STOCK MARKET is higher percolates, accompanied by the all too real surge in input costs (yes, oil really is on the verge of breaking $91 first, and then $100), the margin contraction we have been discussing for over two months is becoming increasingly acute: for a good recent example nowhere is it more evident than in the latest Philly Fed reading. Yet what is true for manufactured products, is far more applicable for food products, whose input costs are determined by the daily vagaries of millions of speculators.

Which means that as the catch 22 of an “improvement” for some courtesy of three year highs in the Nasdaq is perceived by the speculators as an actual improvement for all (which would be the case if stocks were owned uniformly by every layer of society, which is certainly not the case), prices will eventually hit the tipping point where retailers will be forced to start passing on cost increases to consumers.

Enter McDonalds whos executives according to AGWeb, were quoted as saying that “menu prices could rise if the economy improves.” And since after listening to the endless barrage of brainwashing from the mainstream media, one can’t not be left with the impression that the economy is doing anything but improving, conveniently ignoring the fact that the Fed is stimulating it coincidentally via QE2, the next step for the broad part of the US population for whom there is no improvement in anything, which would be the majority of America, is about to get its next whopper (pun intended) of a Bernanke side effect, namely inflation in the most affordable of food product categories: fast food.

But since this is not caught by the core CPI, all shall be well, and the Fed will be able to proclaim, without losing any sleep, that inflation is truly contained, when the only thing that is contained is lending to those who most need it. As for that critical choice of when and how to pass on food costs, here are additional details of the dilemma gripping food retailers, per AG Web:

The big question: When or even whether to pass along those costs. Sure, charging more could help protect profits – but it could also startle customers already shocked by the economy. Restaurants’ choice of strategy in Atlanta and across the country will influence where Americans eat next year, and how much they spend.

Some operators say they plan to raise prices gradually if consumers give them the go-ahead. Others want to hold prices steady and see what their competitors do.

“We’re obviously in a very cost-sensitive industry,” said Robby Kukler, partner at Atlanta-based Fifth Group Restaurants. The company has seen prices rise for beef, chicken and, especially, butter. But Fifth Group has held prices down on most meals, such as fried chicken at South City Kitchen Vinings, fajitas at El Taco and baked manicotti at La Tavola in Virginia-Highland.

“We know people are sensitive to it,” Kukler said. “We just made a conscious effort, because of the times we’re in, to hang steady.”

For those concerned that the recent resumption in limit up openings in various commodity classes is a worrying development, all we can say is “you are absolutely right to be concerned.” Indeed, Bernanke’s Gusher of Endless Liquidity (GEL) is starting to make its way to asset classes far beyond stocks.

Restaurants are not the only companies weighing whether passing along higher prices risks alienating customers. Big food brands such as Dean Foods, Del Monte, Dole and Chiquita Brands are among those at the greatest risk from coming price increases, according to Consumer Edge Research. With agricultural commodities up about 50 percent in the six months leading to November, price increases or smaller profits seem inevitable, according to the Connecticut-based research group.

And herein lies the rub: those very same surging S&P EPS that are supposed to form the bedrock of the number to which some multiple is applied to get a 1,550 year end estimate if one is David Bianco, are about to plunge as profit margins are hit, while fixed costs refuse to be reduced.

Historically, restaurants have not immediately passed on the full extent of cost inflation to their customers, analyst Sara Senatore of Sanford C. Bernstein said. Typically that means meal prices lag for several quarters, squeezing profit margins in the short term.

Profits are defended zealously in the restaurant industry. Profit margins at Wendy’s restaurants are 15.4 percent this year and 11.6 percent at Arby’s, for example. Coca-Cola’s, by contrast, are nearly 30 percent. What this means specifically is that pretty soon America can kiss the various iterations of the dollar menu goodbye.

Executives at McDonald’s said menu prices could rise if the economy improves. The Ohio-based chain has said its commodity costs will increase by only about 2 percent in the fourth quarter. Cheryl Bachelder, chief executive of Atlanta-based Popeyes Louisiana Kitchen, said she expects costs to rise next year. But with the U.S. unemployment rate at 9.8 percent, she doubts that fast-food companies can raise prices much.

Dallas-based Brinker International Inc., which controls Chili’s Grill & Bar and Maggiano’s Little Italy, enjoyed better prices for meat, seafood and poultry in the quarter ending Sept. 29. In the current quarter, about 90 percent of Brinker’s “food basket” is under contract, meaning costs don’t depend on fluctuations in the open market. But much of that protection expires later in 2011. That could put pressure on steak prices.

Executives at Atlanta-based Wendy’s/Arby’s Group say some Wendy’s restaurants will raise prices on selected products this month. The increases will be tailored to places recommended by a software program that crunches data from transactions. Denver-based Chipotle Mexican Grill is prepared to raise prices if necessary, Chief Financial Officer John Hartung said on a recent conference call. But first it wants to see how customers respond to competitors’ price increases.

Elsewhere, fast food price hikes have already taken place… even with 9.8% unemployment. Some increases have come already. Some Wendy’s franchisees bumped the Junior Bacon Cheeseburger to $1.29 after the company switched to a more expensive type of bacon. “We think it was the right thing to do,” Smith said.

Wendy’s/Arby’s, one of the largest fast-food chains in the country, said its commodity costs are 2 to 3 percent higher this year than in 2009. The first half of 2011 is not expected to bring much relief from high beef and pork costs.

Darden Restaurants Inc., the parent company of Olive Garden, Red Lobster and LongHorn Steakhouse, has raised prices about 2 percent this year. It’s important to raise prices steadily and consistently instead of delaying them for years, said Andrew Madsen, Darden’s president and chief operating officer. Sudden price increases can shock guests, he said.

And so forth. Those interested in the full story can read it here. The bottom line is obvious. As the surge in the stock market continus to be equated, totally incorrectly, with an improving economy, prices will increase inevitably, immediately nullifying any benefit brought from the recent tax extension, and pushing all profits to commodity goods speculators, while taking away purchasing power from end consumers.

Keep in mind this is the Fed’s plan, which no longer fights disinflation, but is in the inflation creation business. Luckily, Bernanke is 100% certain he can contain this process. It is then too bad it has already started, and is about to get a whole lot worse.

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