Restaurant Recession Could Signal Tough Times for U.S. Economy

Flagging U.S. restaurant sales could be a harbinger for broader economic peril.

By Andrew Soergel | Economy Reporter July 27, 2016, at 1:40 p.m.

Analysts this week indicated America's recently weak restaurant performance doesn't bode well for the U.S. economy. (GETTY IMAGES)

Analysts are forecasting a "restaurant recession" in the U.S., which is bad news for America's food and drink establishments and potentially even worse news for the economy at large.

Paul Westra, a senior research analyst at Stifel Financial Corp., said in a research note Tuesday that he'd turned "decidedly bearish" on the restaurant industry, downgrading Stifel's stance on 11 different restaurant stocks, including Chipotle Mexican Grill, Panera Bread and Cheesecake Factory.

He and his colleagues now "confidently believe" that the weak restaurant consumer spending seen in the second quarter of the year "reflects the start of a U.S. restaurant recession."

"The catalyst for the current weak pre-recessionary restaurant spending trend is likely multifaceted – U.S. politics, terrorism, social unrest, global geopolitics, economic uncertainty," Westra said. "But, if history is a guide, we warn investors that restaurant-industry sales tend to be the 'canary that lays the recessionary egg.'"

Restaurants aren't themselves a monumental driver of America's gross domestic product, but they're usually a pretty good indicator of what Americans are doing with their money. When times start getting tough, eating out is typically one of the first things to go.

Sales at food services establishments and drinking places – including restaurants and bars – are up about 5 percent over the year, according to the Census Bureau. So it's not as if spending has uniformly taken a nosedive.

But sales have fallen in three of the last six months, and their pace of expansion is undoubtedly easing. Restaurant stock prices have fallen in recent days on the heels of less-than-sterling earnings reports from major restaurant chains like McDonald's and Chipotle. Buffalo Wild Wings actually exceeded sales expectations in the second quarter, but the company indicated it was battling through a "challenging environment" in a statement accompanying its most recent financial report.

Westra said restaurant performance this year, particularly in the second quarter, is shaping up to look pretty similar to the second half of 2000 and the first half of 2007 – the periods that immediately preceded the last two U.S. recessions.

Should this trend continue, Westra said, 2016 and 2017 could end up being "the 'year-before' and 'year-of' a U.S. recession."

"We believe the industry has at least 18 months of challenges ahead in terms of softer same-store sales and higher labor costs because of capacity growth and labor tightness," Andy Barish, managing director at Jefferies investment banking company, wrote in a research note earlier this week.

Barish joined Westra in voicing concern for the industry, saying he was "calling the top of the restaurant cycle." Such a statement indicates restaurant sales are only expected to go downhill from here.

American restaurants are facing challenges on several fronts. Not only has consumer spending in the industry begun to lag, but there's some concern over profitability related to upcoming changes to U.S. overtime regulations and minimum wage hikes.

"Restaurants operate on thin margins with low profits per employee and little room to absorb added costs," the National Restaurant Association said in a statementearlier this year in response to news that the Labor Department was aiming to expand overtime eligibility among U.S. workers. "More than doubling the current minimum salary threshold for exempt employees, while automatically increasing salary levels, will harm restaurants and the employer community at large."

Westra's research note also pointed out that a substantial portion of the U.S. population lives in states and regions where minimum wage increases are expected over the next few years – namely California, New York, Maryland, the District of Columbia, Massachusetts, Michigan and Connecticut, among others.

In the face of increased labor costs and decreased consumption, the future for U.S. restaurants doesn't look great. It's worth noting, though, that the recent pullback in consumer spending could be related to rising gas prices. There's some speculation that restaurants were major beneficiaries of cheap energy costs, as consumers had more disposable cash to throw at fancy meals.

Gas prices are expected to ease slightly as the summer wears on and the U.S. moves away from peak travel season, so time will tell whether the restaurant industry's sales struggles are a blip on the radar or the sign of rough times ahead for the economy at large.