OPINIONFinancing

Welcome to the margin donation era

The Bottom Line: Restaurant companies need to get consumers back in the doors. That could require lower margins, even if investors don’t like it.
Chili's
Chili's generated strong sales last quarter. Investors did not care. | Photo by Jonathan Maze.

The Bottom Line

Brinker International released one of the most surprising earnings reports I can remember on Wednesday.

Chili’s, the venerable bar-and-grill chain, reported same-store sales growth of 14.8%. Outside of the pandemic, that was the best result since, well, at least 17 years. And probably far longer than that. Same-store sales at rival Applebee’s, by contrast, declined 1.8%. Applebee’s isn’t losing customers to grocers, it’s losing customers to Chili’s.

Investors didn’t care, however. The stock fell 11% on Wednesday, because Brinker’s earnings-per-share came in lower than expected and its projections for earnings this year were considered ho-hum.

Welcome to the restaurant industry in 2024. Much of the industry will spend the rest of the year donating profit margins in a bid to get customers in the door. And investors aren’t going to like the results.

Chili’s generated these sales thanks to a low-priced offer, with a burger, fries, drink and chips and salsa, starting at $10.99, coupled with an innovative marketing campaign targeting disaffected fast-food customers. The offer was boosted by social media, where frustration over the prices at chains like McDonald’s and Five Guys are heaviest.

Profits versus traffic is a difficult balancing act even in the best of years. Restaurant operators have to make a profit, because they are for-profit businesses and many of them, including Chili’s, have franchisees that depend on that profitability, not to mention investors and lots of employees.

The industry rightfully went away from price marketing during and coming out of the pandemic, because that’s not how consumers were thinking at the time. They also had to raise prices aggressively to match soaring costs for labor and for food.

But many companies priced too aggressively. Inflation, meanwhile, caused customers to rethink their spending at restaurants as they watched the price of a value meal increase some 40% over the past five years.

The industry has slowed its price increases in recent months. But menu prices continue to rise faster than prices are at grocers. Consumers are noticing this.

The result is a traffic problem that has worsened, hurting sales at many companies. According to Bank of America, restaurant chain spending declined 3.4% month-over-month in July. Get ready for a bunch of disappointing earnings reports three months from now.

Recovering from this will require the industry to put value back on the table in some form or fashion, which has been happening for the past two months. Both McDonald’s and Burger King have already extended their respective $5 bundled meal offers and a bunch of fast-food chains have unleashed all kinds of discounts to get traffic in the door. Even Starbucks has done that.

Discounts, unfortunately, come at a cost. It means profit margins will not be as strong as they otherwise would be.

To be sure, same-store sales aren’t the end-all, be-all. Companies do need to generate a profit and a value war that gets too aggressive, particularly given the high cost of doing business right now, could create all kinds of havoc.

But smart companies understand the best way to offer value and can craft offers that get customers in the door without completely destroying profits in the process.

As for Chili’s, the company is cheering its results, as it probably should. A bar-and-grill chain generating 15% same-store sales at a time when consumers are abandoning such brands in droves is incredible. Even if it came at the expense of some margin and some stock price.

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