We See Limited Opportunities and Waning Pricing Power Ahead for Restaurants in 2023

The restaurant industry has proven surprisingly resilient despite stout macroeconomic headwinds, but between normalizing consumer spending patterns, a widening value gap with the grocery channel, and early signs of price sensitivity, we believe that 2023 is shaping up to be challenging. Despite early indications of a strong first quarter, we continue to expect a softer second half of the year, limiting near-term margin recovery as restaurants are reluctant to outprice their core customer. To this effect, traffic and items per check have declined in each of the past 10 months industrywide—through February 2023—and we continue to view exclusively price-driven comparable store sales growth as a tenuous long-term strategy. We sport a carb-heavy value menu in the industry, with wide-moat Domino’s and narrow-moat Toast representing our top picks, trading at 16% and 18% discounts to our $397 and $21.50 fair value estimates, respectively.

Same-store sales growth has remained strong, clocking in at 5% annually for our coverage during the fourth quarter—though we note that the print represents the second straight quarter of decelerating momentum, perhaps pointing to fissures in consumer willingness to pay more and receive less in dining out occasions. While sales have been robust, mid-20% inflation in both food costs and hourly labor since February 2020 leave restaurant margins about 400 basis points below our long-term forecasts, suggesting a protracted route to recovery. In our view, the best-positioned operators continue to be those with brand-driven pricing power, heavily franchised systems, and strong technology platforms.

While we expect normalizing near-term demand, with consumers typically shifting spending toward the grocery channel during periods of economic pressure, we note that falling producer prices and slowly easing labor markets provide key offsets to slowing top-line momentum in the industry, suggesting that restaurant margins may have found a bottom.