Must-know: Why restaurants are so important to investors (Part 10 of 11)
Food costs in the restaurant industry
Food cost is one of the most important factors contributing to the overall cost of a restaurant business. Some of the major ingredients restaurants use are beef, chicken, cheese, and pork products.
Let’s see how much food costs count as a percentage of sales for some well-known brands.
McDonald’s (MCD) is the biggest player in the restaurant industry. It had a food cost of 34% as a percentage of company-operated sales in the financial year ending 2013. Yum! Brands (YUM) and Chipotle Mexican Grill (CMG) had a food cost of 33% each over the same period. Panera Bread (PNRA) had a food cost of 30% as a percentage of company operated sales.
Any fluctuation in food cost directly impacts margins. Companies buy in bulk. To mitigate cost fluctuations, they use contracts to fix prices for ingredients items.
So what causes the prices of these commodities to fluctuate?
The situation with beef
Let’s take a look at beef, a common ingredient in many fast food menus.
As of 2013, beef prices had increased 6%—to $5.29 per pound compared to $4.99 per pound in 2012, according to the USDA. The price increase was due to several factors. These include a reduction in production due to severe weather conditions in the U.S. and an increase in exports. This increase may result in restaurants raising the prices of their menu items.
Chipotle Mexican Grill (CMG) announced in April 2014 that it would increase its menu prices “somewhere in mid-single digits” to offset the higher food cost.
You should note that a company can’t simply pass on a rise in food costs to its customers. Due to high competition and lower customer switching costs, a customer may simply eat somewhere else. So passing on fluctuating costs might hurt sales.
Note also that you can gain exposure to the restaurant industry through the exchange-traded funds PEJ and PBJ.
Browse this series on Market Realist: