Restaurants will probably have to raise prices even more next year to meet Wall Street expectations, analysts say

After two chaotic years marked by a pandemic, a battered supply chain and rising costs, investors are hoping restaurants’ margins can make a rebound in 2023. But to meet Wall Street’s expectations, some analysts say, those restaurants will probably have to raise prices even more.

“The question for restaurant investors in 2023 is, ‘Who is best positioned to
recapture margins in line with current consensus expectations by increasing prices above inflation?’” Wedbush analysts Nick Setyan and Michael Symington said in a note on Wednesday.

“As the favorable gap vs. grocery inflation declines and goes away entirely, we believe only a handful of names qualify,” the analysts said.

Among them, they said, were names like chicken-wing chain Wingstop Inc. and Domino’s Pizza Inc.
which they said already offered “the most compelling customer value proposition,” citing value deals like Wingstop’s boneless-wing offerings and Domino’s mix-and-match special.

Elsewhere, Wendy’s Co.
“has figured out ‘efficient’ value,” the analysts said. They also liked the prospects for McDonald’s Corp.
saying potential to gain share in Europe was “underappreciated” as the economy there struggles. And they said new or popular items like adult Happy Meals and celebrity meals — the combo meals that have been tailored to the preferences of Travis Scott, BTS and Saweetie — have kept McDonald’s relevant.

Wedbush made those calls as rising prices this year threatened to stifle consumer demand and as analysts there and elsewhere downgraded restaurant names on Wednesday. But many executives at food producers, and at some restaurant chains, have said the demand for essentials, or at least for what they’ve called “affordable luxuries,” has given them flexibility to keep prices elevated.

But the Wedbush analysts pointed to some differences within food pricing across restaurants and grocery stories. They said that full-service restaurants raised prices less aggressively than grocery stores and fast-food chains. And they said the latter two were able to raise prices more due to a more devoted fast-food customer base as cheaper food becomes more important, as well as to grocery stores’ “relative value perception” compared with non-fast-food restaurants.

Within full-service restaurants, the analysts removed Dine Brands Global Inc.
which runs Applebee’s and IHOP, from their “best ideas” list, citing lack of clarity on the company’s debt and interest rates. But they said it would benefit from its all-franchisee model. The larger presence of those independent owners “should allow the company to sustain its value positioning without margin consequences” even as it spends more than rivals on marketing for Applebee’s, the analysts said.

Elsewhere, the analysts downgraded a number of restaurant chains. They downgraded both Denny’s Corp.
and One Group Hospitality Inc.
to neutral from the equivalent of buy, saying both needed to focus more on customers who are prioritizing lower prices. They made the same rating cut for Jack in the Box Inc.
citing a “less favorable value offering” there, as well as “ongoing uncertainty regarding Del Taco’s refranchising path.” Jack in the Box bought Del Taco in March.

Wedbush also downgraded Papa John’s International Inc.
saying profit estimates for next year seemed too high. And they downgraded fast-casual burger chain Shake Shack Inc.
as well, saying it would be “hard-pressed to increase prices even further” without hurting customer demand.

Jefferies analysts on Wednesday also downgraded coffee chain Starbucks Corp.
to hold from buy, saying the stock’s rise since the middle of the year and the threat of a recession made them more cautious.

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