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Where are all the restaurant customers?

Despite a booming economy, restaurants are still struggling with traffic, and here’s why, says RB’s The Bottom Line.
Photograph courtesy of McDonald's

Earlier this week, the owner of Taco Cabana and Pollo Tropical reported some interesting numbers from the second quarter.

Pollo, which once was quietly a hot restaurant chain before overexpansion into unfamiliar markets changed its trajectory, reported same-store sales growth of 3.4% in the second quarter. But traffic was down 1% because customers paid higher check averages.

Then there’s Taco Cabana. It reported same-store sales growth of 3.1%. But traffic plunged 7.1%. Customers, apparently, paid prices or bought items that were 10% higher than they were a year ago.

Both numbers, extreme though Cabana’s is, illustrate the industry’s fundamental challenge in 2018: It’s really hard to get customers coming to your existing restaurants more often.

The two biggest restaurant chains in the U.S., McDonald’s and Starbucks, both reported same-store sales growth coupled with traffic declines. Both chains are facing criticism from some investors over capacity issues.

Many are wondering whether Starbucks is overstored.

And at McDonald’s, the company has seen an erosion in customer count this year, even though it effectively brought back its Dollar Menu, though with additional $2 and $3 tiers. The menu has been good at getting people to spend more and bad at getting them to come in more often.

Maybe the most illustrative example is Red Robin, which was hammered last week after reporting preliminary results that were disappointing. Same-store sales decreased 2.6%.

Traffic was down 0.7%, meaning that customers paid lower prices (3.3% lower) during the quarter. As it turned out, the company ran a promotion that did little to generate traffic.

According to the June Technomic Chain Restaurant Index, traffic fell 3.1% in June among the 200 largest chains, following a 4% decline in May. That helped wipe out traffic increases of at least 1.2% each month through April.

To be sure, some chains are thriving. Wingstop reported strong results despite price increases. Domino’s Pizza seems to be finding new ways to get customers in the door all the time. And Applebee’s is using low-cost drinks to drive traffic into its casual-dining restaurants. Noodles & Co. has engineered an impressive comeback.

But the environment remains broadly weak despite an economy that says it should be the other way around. Unemployment is below 4%, for instance. The gross domestic product rose 4.1% in the second quarter. Wages have started growing.

All of that should be good news for restaurants. Yet, for the third year in a row, industry traffic remains a major industry challenge.

So what’s going on?

As we’ve said for some time, the industry is oversupplied. Restaurant chains have added a lot of locations in the aftermath of the recession. That includes casual-dining chains, which expanded consistently year after year until 2017 despite a market that was simply unfriendly to their service models.

Add in competition from grocers, c-stores and other industries, and it’s an incredibly competitive market.

It’s difficult to remove supply from the system, as franchisees keep their businesses going while lease terms keep restaurants from closing more locations. There are numerous struggling restaurant companies that are holding on and even looking to acquire additional concepts to improve their profitability.

That includes Real Mex Restaurants, the owner of El Torito and Chevys, which was apparently looking to buy another chain before it filed for bankruptcy this week. It has a buyer, but for a price that’s about a quarter of the amount of secured debt on the company’s books.

The $200 million plus in debt, by the way, looks even more remarkable considering that this is its second bankruptcy in seven years.

At what point do lenders stop lending money to weak restaurant chains?

But the real problem might be on the demand side. While the economy might be booming, for instance, wages have not been increasing that much, which might have kept demand for casual-dining chains to a minimum.

Higher housing and other costs among younger consumers might be holding back spending.

And the industry is changing. Listen to any of our podcasts with industry executives, for instance, and you’ll hear a common theme: Takeout is rapidly increasing.

While that could hold potential for limited-service chains and delivery providers, at the end of the day, if people are more likely to eat at home, then maybe they’re more likely to cook at home, too.

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