On the Money: Food Costs on the Up and Up

Rising wholesale food prices continue to hamper restaurant margins.

By David Farkas, Senior Editor -- Chain Leader, 11/1/2007

The good news: The economy probably isn’t headed for a recession. The bad news: The outlook for restaurant profitability remains as tough as ever as food costs continue to climb.

That was the message of three experts in a UBS conference-call series hosted by restaurant analyst David Palmer. In separate calls, Jerry Dryer, editor of Dairy & Food Market Analyst, and Kevin Good, senior market analyst for Cattle Fax, offered an outlook for dairy and meat prices, respectively, in 2008 and beyond. Finally, UBS economist James O’Sullivan discussed key economic drivers affecting consumer spending.

Price Hike

Dairy costs, for example, have risen significantly since last May due to sharp increases in energy costs and product demand, particularly abroad. "The whole [dairy] distribution chain uses energy," Dryer said, noting cheese had climbed to $2.20 a pound in June. He predicted cheese will cost $1.65, about 30 cents higher than its five-year historical average, in 2008.

Although dairy prices have retreated, Dryer wasn’t predicting sizeable declines in the next 18 months, despite a recent increase in production. "We are operating with a new floor, and we are not going back to historical five-year averages," he said.

Restaurant chains contributed to the demand, buying up dairy products while prices were low in ’05 and ’06, which encouraged promotions. Developing countries are importing dairy products at record levels. Milk exports totaled 9 percent of production this year; next year, they will climb to 12 percent.

"The international market is very significant," Dryer added, noting the weak dollar makes American products attractive.

Trade-offs

Both domestic and international markets are increasing their demand for American beef products despite flat production levels due largely to drought conditions and the rise in feed costs.

"Wholesale prices will be up 2 to 5 percent, and retail about the same," Good said. Production, however, will remain flat for the next two years, he predicted, despite an increase in the number of cows slaughtered.

Higher prices for Choice grade beef has hampered margins at casual-dining chains. "It drove [them] away from the Choice products," Good surmised. "Instead of using filets and porterhouses, they’re now using flat iron steaks or moving back on the carcass to sirloins to cheapen up their end cost. If they were to use the same product a year ago, they would have to raise their prices."

Good also predicted fast-food companies will import more ground meat in ’08 because U.S. production levels are flat and prices are rising. Exports are climbing, particularly to Japan and Korea, but levels remain below record highs of ’03, he noted.

O’Sullivan, the economist, said that while consumer spending was slowing this year, job growth remained relatively strong and consumer loan defaults were up only modestly. He said he doesn’t expect the economy to slide into a recession.

It’s good news for restaurants that have price flexibility.