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Big brands keep raising prices to beat inflation—but consumers are still buying

Luke Sharrett/Bloomberg via Getty Images

Good morning,

“Consumers are willing to pay up for brands and trademarks that carry strong equity,” Gerald Pascarelli, an SVP of equity research at the investment firm Wedbush Securities Inc., told me.

I asked Pascarelli about the current purchase patterns of consumers indicated in third-quarter earnings reports of major brands like Coca-Cola. And Nick Setyan, managing director at Wedbush covering the restaurant sector, shared some insight on Chipotle. Despite historic inflation, many are willing to absorb price hikes for a Coke and a burrito bowl.

“The non-alcoholic beverage companies will continue to take pricing as long as there is not a material impact to demand elasticity,” Pascarelli says. For all soda companies, rate increases are currently a component of the strong price mix, he says. The other component is price pack architecture. “Offering smaller pack sizes protects the consumer in terms of absolute out of pocket costs, but it also drives a positive mix shift for the manufacturers which is another component of pricing,” he says.

In the third quarter, The Coca-Cola Company's (NYSE: KO) price mix was up 12% vs. the same period last year, Pascarelli says. The beverage giant reported on Tuesday that net revenues grew 10% to $11.1 billion in the quarter. It topped expectations of $10.52 billion. The volume of products also rose 4%. KO is also introducing packages at lower price points.

“All companies are dealing with ongoing high levels of commodity cost inflation,” Pascarelli explains. “And while they are always looking to drive efficiencies and streamline their cost structure, taking outsized pricing has been the best offset.” This has resulted in “above algorithm revenue growth which is helping to protect profitability,” he says.

The coffee and soft drinks company Keurig Dr Pepper Inc. (Nasdaq: KDP) reports its third-quarter results today. KDP announced on Monday that Sudhanshu Priyadarshi was appointed the new CFO, effective Nov. 14. This follows former CFO Ozan Dokmecioglu's promotion to CEO in July. Priyadarshi was most recently CFO at Vista Outdoor Inc., a sporting and outdoor goods company. He started his career at PepsiCo, where he spent 14 years in roles, including as CFO of global R&D and PepsiCo Global Nutrition Platforms.

Priyadarshi’s initial priorities will likely focus on delivering long-term targets to drive mid-single-digit revenue growth and high single-digit EPS growth, Pascarelli says. To do that, implementing the necessary pricing as an offset will be key, he says. Another key focus will be oversight and integration on any potential M&A deal to scale the business inorganically, he says.

Taking a look at the restaurant industry, sales in the third quarter at Chipotle Mexican Restaurant, Inc. grew 14% year-over-year to reach $2.2 billion as comp sales grew 7.6%. In August, Chipotle increased prices for the third time in 15 months, bringing prices up 13% from the third quarter of last year. And, in early October, "there was a price increase in about 700 restaurants to address pockets of outsized wage inflation,” CFO Jack Hartung said during the earnings call on Tuesday. In each restaurant, menu prices increased between 2% and 3%, which, overall, had a company-wide impact of about 0.5%, Hartung said.

In the quarter, the cost of sales was 29.8%, a decrease of about 50 basis points from last year. The company expects the cost of sales to remain about the same next quarter. However, in Q4, price increases may approach 15% year over year, before it drops down to 11% in the first quarter of next year, Hartung said.

But as Chipotle continues higher prices, will primary drivers of sustained growth like loyalty and menu innovation be compromised? “Management will have to be more careful and more thoughtful when it comes to pricing levers it can pull,” Setyan says.

“For example, part of the incremental pricing in Q4 vs. Q3 is a change in the loyalty rewards structure (more points needed for free items),” he says. And the current limited time offer (LTO) is beef, which is “priced at a noticeable premium” to the regular menu offerings, Setyan says. “That may explain the lack of relative success (compared to brisket this time last year),” he says. “The next one should be more palatable as it’s a chicken LTO.”

However, Chipotle isn’t alone in price increases, Setyan says. “[McDonald’s] menu price increases are in the 10-12% range,” he says. “Price increases in grocery are even higher. So, we’re seeing pressure on the lower-income consumer across the industry,” Setyan says. Chipotle defines lower-income as less than $75K household income; approximately 40% of customers, he says.

Price hikes are helping to lift revenue for big brands. But at the end of the day, the ball is in the consumer's court.


See you tomorrow.

Sheryl Estrada
sheryl.estrada@fortune.com

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This story was originally featured on Fortune.com

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