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2018 could be a better year for restaurants

Tax cuts and wage growth could fuel sales, but industry challenges remain.

Lower taxes and wage growth could conspire to get the restaurant industry out of its two-year slump in 2018.

That, at least, is the early read from some analysts expecting a stronger year in 2018.

The bullish sentiment could be seen in a late-year increase in industry stocks—restaurant stocks increased 3.5% on average in the last three months of the year, according to a Restaurant Business analysis.

The increase was fueled in part by tax reform, but also by a late improvement in same-store sales at many chains, including the long-beleaguered casual-dining sector.

Still, higher labor costs and a changing consumer could dampen any growth in the coming months. And some of the same issues that kept sales down over the past two years, like concerns about industry oversupply and competition from grocers, will remain a factor.

“We expect the sales environment in 2018 to be fairly similar to 2017,” Jefferies analysts wrote in a note last month. That would be bad news for the industry, given persistently weak same-store sales all year.

The biggest wild card in the industry heading into the coming year is wage growth.

The economy has consistently added jobs for years now, including 250,000 private sector jobs in December, according to the human resources firm ADP.

Yet that growth didn’t come with wage growth. As such, that might have kept some consumers from spending as much as you’d think, considering the employment growth.

Sara Senatore, analyst with Bernstein Research, wrote in a note that there are signs that wages are starting to rise. If wages do go up, consumers are more likely to spend.

Stephen Anderson, analyst with Maxim Group, wrote in a note last month that the “macroeconomic environment remains conducive to what we believe will be a solid 2018.”

Delivery is another wild card. Chains from McDonald’s to Outback Steakhouse to Wendy’s are adding delivery around the country, and early reports suggest that business is incremental—meaning they’re taking business from people who would otherwise eat elsewhere.

That could provide some top-line benefit, Jefferies wrote, before adding that value remains the “key driver in consumer decision making.”

Fitch Ratings, a corporate credit ratings service, said in its 2018 outlook for U.S. retail and restaurant companies that spending on food away from home should grow 3% to 4%, due to 2% to 3% same-store sales and 1% unit growth.

Fitch believes that fast-food chains and coffee and snack shops will outperform casual-dining companies.

There’s potential that tax cuts that were part of the reform package signed last month could also fuel spending, particularly among lower- and middle-income households. Consumers will frequently spend savings from taxes or gas at restaurants.

A more direct impact will be on the taxes many restaurants will pay. Anderson said that companies like Habit Restaurants, Zoes Kitchen and Chipotle Mexican Grill are most likely to benefit from changes in the tax rate. Dave & Buster’s, Del Taco and Domino’s Pizza could also benefit, he wrote.

But even the most bullish of analysts are thus far cautious about the overall environment heading into 2018, given the fundamental challenges that dogged restaurants last year still exist.

One of those challenges is labor costs.

“Restaurants remain on the front lines of these wage pressures,” Senatore wrote.

Restaurants have added hundreds of thousands of jobs in the past couple of years, draining the labor supply and leading to a spike in wages.

Wages in leisure and hospitality industries, which include restaurants, have increased 3.8% over the past year, according to federal data, far higher than the 2.5% overall wage growth over that period. That is taking a toll on restaurateurs’ profits.

In addition, while companies are adding technology to improve their businesses and efficiency and take advantage of delivery growth, that could hurt companies’ fiscal health, particularly in light of the margin challenges the industry faces this year, according to Fitch.

That could be particularly problematic at smaller chains working to keep up with bigger companies like McDonald’s and Wendy’s that are aggressively adding technology inside of their restaurants.

Another challenge that isn’t going away is supply. The restaurant industry remains oversupplied, which has made traffic growth more challenged over the past two years.

Still, Anderson wrote, there are signs that the supply concern is abating as chains cut growth projections and close locations.

Fitch, for instance, suggests that fast-casual chains will open fewer locations, and casual-dining companies will close more locations in 2018. That would reduce concerns about oversupply.

Industry pricing is another challenge. Restaurants’ same-store sales slowdown in 2016 and 2017 coincided with a widening gap in inflation between them and grocery stores.

Fitch believes that gap will persist this year, as restaurants continue to deal with high labor costs that are not as big a problem for their nonrestaurant competitors.

The challenges make Jefferies believe that consumer spending will be “mixed” in the coming year, with “choppy earnings, even with favorable tax implications.”

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