The U.S. Economy Shows Signs of Slow Expansion

A variety of economic indicators suggest that the U.S. economy is maintaining its slow expansion. Real gross domestic product in the U.S. increased at an annual rate of 2.0% in the third quarter of 2010, based on an advance estimate from the Bureau of Economic Analysis. This is a slight increase over the 1.7% increase in the second quarter. The Conference Board’s Leading Economic Index (LEI) for the U.S. also increased 0.5% in October, following a 0.5% increase in September. This continued upward trend suggests modest economic expansion will continue.

The economic recovery appears to be taking hold in both the manufacturing and non-manufacturing sectors:

• Manufacturing. Supply executives indicate that manufacturing activity expanded in October for the 15th consecutive month. Recovery in autos, computers, and exports were key drivers.
• Service. In the non-manufacturing sector, economic activity was also positive. During October, the Non-Manufacturing Index (NMI) registered 54.3%, 1.1 percentage points higher than in September. This represented growth for the 10th consecutive month.

Although wholesale prices rose in October, there were few signs of inflation as the cost of food, cars, and computers fell. According to the Labor Department, the Producer Price Index rose 0.4% in October, the same as in August and September. Wholesale food prices fell slightly, surprising economists who believed food prices would increase due to higher costs for corn, soybeans, and sugar. Although grain prices rose in October, food companies are not yet passing increases on to consumers.

Restaurant Traffic is on the Rise, Though Consumers Are Keeping an Eye on Check Size

In recent months, the restaurant sector has seen signs of stability. Operators have indicated that they expect same- store sales to be higher in the next six months.

There are several signs that consumer traffic at restaurants is on the rise:

• Growth in same-store sales. Restaurant same-store sales improved 0.8% in October with casual dining sales exceeding fast food sales. Research by RBC Capital Markets showed that same-store sales in casual dining increased 0.9% between September and October, compared to an increase of 0.7% in fast food. In addition, all five day parts remained positive and increased during October.
• More restaurant visits by families with children. According to the NPD Group, families with children visited restaurants in slightly greater numbers this summer, ending a three-year downward trend. This suggests families have become recession weary. For the quarter ending in August 2010, restaurant visits by parties with children increased 1% over the prior year period. Families with kids represent a large segment for the restaurant industry, accounting for 14 billion meals and snacks and $70 billion in sales in 2009. Operators can capitalize on this shift in consumer behavior by offering promotions that target parties with kids and that recognize families’ financial concerns.
• Increased credit and debit card spending. In October, consumer credit and debit card spending in restaurants and bars grew by 9.5% year over year. This was the highest growth in more than 18 months, according to payment processor First Data. This growth at eating and drinking establishments was higher than the growth at supermarkets (3.8%), retail (5.2%), and hotels (6.9%).
• Higher levels of restaurant gift card activations. Activation of new gift cards in October was up 17.8% year over year at quick service restaurants and up 1.3% at casual dining restaurants.

Despite these positive signs, consumers are still watching their spending. Although transactions in restaurants and bars in October grew by 12.6 %, the average ticket size decreased by 2.7%.

Restaurant Operators Are Optimistic About Sales, But Worried About Food Costs

Restaurant industry analyst Larry Miller of RBC Capital Markets reports that many operators (51%) expect better sales trends in November compared to October. Most operators at fast food, casual dining, and fine dining restaurants expect sales to improve over the next six months. Based on RBC Capital Markets’ research, fine dining restaurants are most optimistic, with 86% expecting sales trends to improve.

Despite the rebound in restaurant traffic and sales, restaurants remain concerned about food costs. Operators expect commodity inflation of 1.9% over the next six months. Ground beef and the cheese/dairy category are expected to have the least favorable costs.

But, There Are Reasons to be Optimistic About Margins

Looking ahead to 2011, a recent article in Nation’s Restaurant News (11/24/10) mentioned a report by an analyst from Wells Fargo Securities which indicated that in 2011, restaurants may begin increasing menu prices without fear of losing customers. Wells Fargo has concluded that in the coming year, restaurants may be better positioned to pass along price increases, such as increased commodity costs.

Already, some chains, like Texas Roadhouse—a casual dining chain— have begun to test modest price increases, and McDonald’s is expected to increase prices during 2011 as well.

The chart from NPD Group shows that even in early 2010 consumers became less price sensitive. They were trading down less frequently and price was not as much of a factor in deciding where to eat and what to order.

Less price-sensitive consumers and the ability to raise prices provide optimism around margins in 2011.