Restaurants see worst performance in 3 years after payroll tax increase

Bloomberg NewsMarch 20, 2013 

DARDEN EARNS

Pedestrians pass in front of a Red Lobster restaurant in New York, U.S., on Wednesday, Sept. 19, 2012.

VICTOR J. BLUE — Bloomberg

Restaurants are reeling from their worst three months since 2010, as American diners spooked by higher payroll taxes cut back on eating out.

Sales at casual-dining establishments fell 5.4 percent last month, after declining 0.6 percent in January and 1.6 percent in December, according to the Knapp-Track Index of monthly restaurant sales. This was the first three months of consecutive declines in almost three years, with consumers caught in a “very emotional moment,” said Malcolm Knapp, a New York-based consultant who created the index and has monitored the industry since 1970.

“February was pretty ugly” for many chains – and probably will be the worst month of the year – after January delivered an “initial blow” while Americans grappled with increased payroll taxes and health-care premiums, rising gasoline prices and budget debates in Washington, Knapp said. “It’s important to keep in mind that companies also are facing unusually tough comparable sales because of favorable weather in 2012,” so the result is an industry that’s been “a lot softer so far this year.”

Even as consumers open their wallets for bigger-ticket purchases including cars and furniture, weakness has surfaced at full-service companies such as Brinker International and Darden Restaurants, as well as limited-service chains including McDonald’s and Yum Brands.

U.S. paychecks have shrunk this year after Congress and President Obama let the tax that funds Social Security benefits revert to 6.2 percent from 4.2 percent. Meanwhile, the average price of a gallon of regular unleaded has risen about 12 percent since Dec. 31, to $3.69, including a one-week jump of 17 cents between Jan. 27 and Feb. 3, based on data from Heathrow, Fla.-based AAA, the largest U.S. motoring organization.

“That one-week spike was a killer; it destroyed sales in the first week of February,” Knapp said.

All this has “put meaningful pressure on the discretionary purchasing power” of Darden’s customers, causing the company to pre-announce a decline in same-restaurant sales for Olive Garden, Red Lobster and LongHorn Steakhouse in the three months that ended Feb. 24 compared with a year earlier, CEO Clarence Otis said in a Feb. 22 statement. The Orlando- based company is scheduled to report fiscal third quarter earnings on Friday.

Brinker, Bloomin’ Brands, DineEquity, Bob Evans Farms and BJ’s Restaurants – members of the Bloomberg U.S. Full-Service Restaurant Index – also have cited these headwinds. The index, which includes 21 companies, has underperformed the Standard & Poor’s 500 Index by 8.2 percentage points since May 29.

Consumers and industry contacts in surveys conducted this month by RBC Capital Markets said higher payroll taxes have been the biggest impediment to sales this year, hurting business for about 63 percent of companies, up from 36 percent last month. Meanwhile, 54 percent of Americans said they already cut back on dining out or intend to do so, the No. 1 reduced expense, followed by clothing and vacations.

“People are acting fearfully, or you could almost say rationally in a way,” because it’s not surprising they change their dining habits when they feel less confident, said Larry Miller, an analyst in Atlanta with RBC. The difference of five guests a day could move a restaurant’s traffic counts by 1 percentage point because the business is “very sensitive to marginal changes.”

Casual dining is “definitely being squeezed” because “it’s not food on-the-go and it’s not high-end food for people trying to treat themselves,” said Matthew Beesley, who helps oversee $3 billion of assets as head of global equities at Henderson Global Investors Holdings in London. That’s making many investors wary about sales prospects for companies such as Darden, he said.

“It seems to me Darden is caught between those two buckets of expenditures,” Beesley said. A sit-down meal away from home is “extremely discretionary,” while there’s also an excess of supply.

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