S&P warns of trouble cooking in the restaurant sector

Photo: Jack Culbertson/Getty Images

U.S. restaurants have been a beacon of hope in the moribund brick-and-mortar retail picture, but they now face trouble of their own, analysts at ratings agency S&P Global warn.

What's happening: "Already, cracks are showing across our rated restaurant universe," Diya G. Iyer, S&P's primary credit analyst, wrote in a note to clients Tuesday. Iyer worries rising wages and increasing delivery costs will weigh on fast food restaurants while changing millennial dining preferences will hurt casual dining.

Details: Despite some improving brands, the rise of food halls and continued pressure on lower-income households this year will work against much of the fast casual and fast food sector, Iyer warns, where Pizza Hut, Wendy's and BossCo (parent of Checkers) have all been downgraded to CCC+ ratings with negative outlooks.

By the numbers:

  • "A new normal is unfolding," Iyer says, with U.S. restaurant sales increasing only 3.6% last year versus a compound annual growth rate of 6.4% between 1970 and 2019, according to the National Restaurant Association.
  • The most concerning development is that industry traffic hit a 9-year low with a 4% reduction in February, while the average cost of a check in restaurants hit a 10-year high, according to U.S. restaurant industry benchmarker MillerPulse.
  • Price increases look unsustainable given negative industry traffic since 2015.

Other worries:

  • Remodeling growth is expected to slow after years of capital spending on technology, especially in casual dining.
  • Restaurants will have to raise prices because of swine flu in China, which has slowed global pork supply.

Yes, but: S&P notes that there have been zero restaurant defaults in the last two years and only one a year in the years prior.

Watch this space: "We will continue to closely monitor refranchising efforts that McDonald's Corp., Wendy's, and other major players undertook in recent years," Iyer writes.

  • "The approach passes costs on to the franchise operators, improving margins and free cash flow generation at the franchisor level. But in our view, in some cases it causes potential for strife if mom-and-pop owners feel they shoulder too much expense to execute on the major transformations."

Go deeper: How fast food is pandering to the youths

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