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Winners and losers in the restaurant space

Jefferies managing director Andy Barish discusses the state of the restaurant industry, including labor shortages, wage concerns and what companies stand to benefit from current conditions.

Video Transcript

[MUSIC PLAYING]

- Well, the restaurant industry is really a reflection lot of the trends we've been discussing briefly. On the one hand, benefiting from the demand that's happening as the US economy reopens. But on the other hand, those input costs are going up. Everything from food to labor. So kind of where do we sit right now? And which companies are the best positioned? Andy Barish is here to help us answer that question. He's a restaurant analyst and Jefferies managing director. Andy, thanks for being here.

So before we dig into the specific names, at a very high level, kind of where are we in this cycle? Because on the one hand, you would have thought this would have been a great time for the restaurants with the reopening. But now, they're being hit by those higher costs.

Yeah, good morning, Julie. Thanks for having me. It's been pretty amazing, actually, to see the demand pick up in the industry, particularly as we lap now the toughest part of the pandemic. Last year, obviously. But what most restaurants are reporting as we've gone through most of first quarter earning season is numbers compared to 2019 or pre-pandemic levels. And what we've seen broadly is sales increases above the 2019 levels.

So demand has surged. Restaurants have, for the most part, not only made up for the issues last year during the pandemic but have now exceeded pre-pandemic sales levels. And we expect, you know, strong demand to continue at least, you know, through the summer and into the fall.

- And it's Myles here. Before we get into a couple of the specific names that you have in your coverage area, I wanted to ask you about a couple of the trends that, you know, we here in the media are discussing all the time, which is labor costs, and input costs, and how you as an analyst think about those two things in your coverage area today. And whether perhaps maybe we make too much of how that feeds into the model at least as far as you see it.

ANDY BARISH: Yeah, that's definitely becoming more and more of a challenge to the income statements. But a couple of things going on. First of all, you've got about half the industry is asset light or most of the QSR, quick service restaurant companies are franchiser. So they don't feel the direct pressure of inflation costs. That's put more down into their franchisees.

And then what I think you've had going on is wage inflation for a long time in the restaurant industry. This is not a new thing. Maybe some folks thought there would be some relief with some slack in the labor market. But to your point, it has been really, really difficult snapping restaurants. And that mid single digit wage inflation is going to continue.

I think a couple of things to offset it. First of all, the industry has rationalized to some extent with closures through the pandemic. So there is pricing power. And then secondly, I think, you know, the ability to show efficiencies during the pandemic has really brought about some new ways of doing business, new productivity measures, where although the labor wage rates are going up, the number of hours staffing in restaurants has not-- you know, has actually gone down as restaurants have found efficiencies.

So we are looking at it closely. We are concerned. Commodity prices also inflating, you know, a few percent here for most restaurant inputs. It will have to be watched. But right now, I think the demand surge is really continuing to catch investors' eyes.

- Andy, is McDonald's good investment here? Stock's up about 10% year to date. That's OK. But I see the potential chicken shortage. I see labor inflation. I even see a company like Burger King that just launched their new dollar value menu as a potential risk. How do you see it?

ANDY BARISH: Yeah, for sure. I mean, we have a buy on McDonald's. We think it's the most defensive play in the group as well as going on the offensive as well. And a couple of quick points there. Again, it is an asset like mostly franchise model. So the direct labor and commodity pressure is something that their franchisees will bear more than the company.

We believe, you know, in the chicken wars, if there's a chain that can manage supply chain, you know, better than anybody, it is McDonald's given their size and scale. And obviously, the importance of supply chain in a business like that. So we think, you know, the continued opportunity in the chicken category, including the launch of chicken sandwich. And in a couple of weeks, a collaboration with BTS around famous orders, which will highlight chicken Nuggets. So we think the momentum will continue.

And then obviously, the European business, which is quite large for McDonald's has lagged to some extent. So hopefully, we'll start to see that business pick up as we move through the rest of the year. And that should also create some tailwind behind the numbers for McDonald's. So we continue to like the stock here.

- And Andy, speaking of chicken wars or speaking of chicken generally, you like El Pollo Loco too. We spoke to the CEO last week about how he's managing through some of the costs. Obviously, in a very different position from McDonald's size wise but perhaps then more of a growth opportunity. But let's talk the cost question for them as well. Do they have enough pricing power to make up for the increase in those chicken costs?

ANDY BARISH: We think they do. And this is a California based business with a lot of their system in California. So they've been managing through the move to $15 minimum wage in the state of California for three or four years now. So they understand the pricing that it takes. They've been through the worst of it actually. And on the-- excuse me, on the chicken side, they're able to contract. And they are seeing a little bit of inflation. But it appears as if it's going to be manageable at this point. Assuming there is availability of product which to this point they haven't had an issue with.

- And then, Andy, quickly before we let you go, I want to ask about my personal favorite and your coverage area, Shake Shack coming off a really tough quarter. You got a hold rating on that name. Where is that story at today for a company that with more urban locations in general, in the airports, and the stadiums has really gotten hit harder, I think, than a lot of that peer group from COVID?

ANDY BARISH: Yeah, you're exactly right, Myles. The recovery is lagging because of the urban side of things. If you just looked at suburban, they would actually be up at this point, again, versus 2019 levels, which is pretty phenomenal and just shows that the changes obviously in consumer demand created partly by the pandemic.

The problem with Shake Shack has always been valuation. It has been incredibly high. Obviously, since last week's first quarter earnings, it has pulled back to some extent. But, you know, we're still at a hold rating. We love the long term growth prospects on the unit side. But we want to see how things shake out here over the coming months before taking a look at the stock here.

- Andy, thanks for your time this morning. Really interesting stuff. I covered a lot of ground. Andy Barish of Jefferies, appreciate it.