Previously in this series, we mentioned that food inflation can raise the cost of sales for a restaurant. In an earlier Market Realist article about McDonald’s (MCD), Must know: McDonald’s major operation costs, we learned about the impact of rising beef prices on the company. Unless a restaurant can pass on the costs of sales to its customers’s—in this case, more expensive food—its profit margins take a hit.
Domino’s Pizza, Inc.’s (DPZ) cost of sales, including food costs, was $313 million in 3Q14. This equals 65% of revenues, and contrasts with $283 million, or 62% of revenues, in 3Q13. Domino’s faced inflation from the higher cost of cheese, which was $2.04 per pound. According to the company, cheese represented an overall increase of 4.2% in food costs, compared to the same quarter a year ago.
The company did not pass these costs on to customers by hiking menu prices in the third quarter. Management did note, however, that some of its franchises “raised prices.”
It’s not easy for restaurants to simply raise menu prices and pass on the costs to the customers. Companies can lose customers to the competition if a price increase is not done industry-wide. Yet some restaurants increased their menu prices and managed to deliver stronger sales regardless, including fast-casual restaurant Chipotle Mexican Grill (CMG).
An investor who would like to invest in a broader section of the restaurant industry might consider an ETF such as the Consumer Discretionary Select Sector SPDR Fund (XLY), which includes Chipotle Mexican Grill and Yum! Brands, Inc. (YUM).
As for Domino’s, its higher food costs were mitigated by higher sales and a better product mix. The company says it experienced higher sales of chicken items, which helped balance the cost of sales increase.