Food commodity inflation
In the last part of this series, we learned that Texas Roadhouse (TXRH) increased its menu prices in 2011 through 2013 because of inflationary pressures from commodities. In 2013 alone, commodity inflation of about 7% increased its cost of sales to 34.9% from 33.8% in 2012. Commodity inflation in 2012 was 6.4%. This inflation was because of higher beef and pork costs in 2012 and 2013.
In the above chart, we can see the inflation for beef increasing from 2012 through 2013. Beginning January 2012, the meats index, which includes the prices of beef and pork, was 230.5. This index increased to 231.7 as of December end 2012 and 236.9 in 2013.
Commodity inflation, as we saw above, can increase costs of sales. The company doesn’t always have the flexibility to pass on these costs to customers by simply increasing menu prices, as it may risk losing its customers to competitors. This would squeeze the company’s operating margins.
Mitigating the risk
Restaurants sometimes hedge this risk by entering contracts to procure supplies at a fixed cost in the future. TXRH has 35% to 40% of its overall food costs under contracted, fixed prices for 2014. Alternatively a restaurant may also heavily push lower-cost or additional items to its customers to increase the average check and maintain margins.
However, an industry-wide increase in price doesn’t affect restaurant companies. Bloomin’ Brands (BLMN), which operates Outback Steakhouse, also increased its menu prices by 2.1% to 3.4% in 2013. Restaurants like the Cheesecake Factory (CAKE) and Longhorn SteakHouse owner Darden Restaurants (DRI) have also increased their menu prices.
You may consider the Consumer Discretionary Select Sector SPDR Fund (XLY) to invest in some of the restaurants mentioned above.
The company can also run aggressive marketing and promotional campaigns to offset the above risk. Let’s look at this in more detail in the next part of this series.