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Time to Short the Restaurant Chains?

Over the past year I’ve suggested shorting the for-profit education stocks, muni bonds, US Treasury bonds, and junk bonds. And so far, not so good. Asset prices just keep floating on the tide of liquidity pouring out of the Fed. As the saying goes, it’s all one market these days, with even inversely-correlated assets like stocks and gold rising together.

But damn it, in a dysfunctional system like this the short side is, eventually, the place to be. Just as it’s all one market on the upside today, it will soon be all one market in reverse, as everyone dumps paper as fast as their brokers can process the trades. The above shorts will work, and they’ll be joined by lots of others including, almost certainly, the big restaurant chains.

This particular story begins with me bumping into a friend who owns a popular local restaurant and has spent the past few years buying junior silver miner stocks. Being guys, we skip the pleasantries and go straight to trying to top each other with tales of doublings and triplings and profits taken way too soon. Then he says, “Good thing for silver too because food prices are killing me.” It seems that the wheat flour, potatoes, and tomatoes that his cooks turn into hash browns, toast and sandwiches are through the roof. “Damn,” I say, “maybe we should be shorting the restaurant stocks!” We both laugh, and then stop and look at each other as the realization dawns that we really should be shorting these companies, since they seem to be caught in a classic margin squeeze.

Imagine, for example, that you’re running an Italian chain like Olive Garden (DRI). Pasta is your core product and wheat, its main component, has doubled since June. You have no choice but to raise menu prices, squeeze your labor costs and/or downgrade your entree quality — or just eat the higher prices. Depending on what you choose, the result is either diminished customer experience or lower profits.

Now pretend you’re running Chipotle Mexican Grill (CMG), which sells a lot of corn tortillas and taco shells. With the price of corn soaring, that part of the menu is getting more expensive and, because cows and chickens are fed mostly on corn, meat prices will eventually have to rise commensurately. (See Record US cattle, hog prices seen on shrinking herds, China.) So inputs across the board either are or will be way up. Same problem as Olive Garden, and same eventual result.

Meanwhile, the stocks of the major restaurant chains have held up pretty well, with most on the chart below still close to their 12-month highs. There are three reasons for this: First, consumers have been spending a bit more lately, giving restaurant chains pretty good year-over-year comparisons. Second, most big chains — and the wholesalers that supply them — probably use futures contracts and long-term sourcing deals to lock in prices months in advance, so these guys are still working with relatively cheap inputs. And third, like I said, all asset prices are up, so it shouldn’t be surprising that restaurant stocks are as well.

But at some point food prices will work their way through to the menu, while rising interest rates or some other catalyst will suck some liquidity out of the stock market. Then they’ll be talking about a perfect storm for the restaurants and today’s prices will look like a short-seller’s dream.

13 thoughts on "Time to Short the Restaurant Chains?"

  1. A friend of mine has a chunk at risk on the unconfirmed BK of IHOP in Utah. This is a group of 92 franchised restaurants. Apparently a group of creditors has banded together to get a Trustee appointed to oust management.

    Again, I haven’t confirmed and might be passing along gossip. Still, it’s ironic a little guy like me would hear this on the day John Rubino advocates shorting the big restaurant chains.

  2. Good in theory, bad in practice. You have to consider the fact food is a minimal part of their cost structure. Flour, sugar, corn… yes it’s all rising. But that’s perhaps 20% of what the restaurant pays. It’s labor, lighting, heat, transportation, refrigeration, advertising, hiring, training… I could go on and on and on.

    If you’re going to short something, do it because the fundamentals are broken for a main input. Oil and gas surging? Short transport companies. There are good options in this market, but you really have to examine what percentage of their fundamentals are in jeopardy.

  3. One thing I know is, Pasta is cheap, cheap, cheap, to buy.
    Even paying retail I can buy a one pound box of pasta for a buck a box, a name brand not the store generic.
    Same with potatoes and veggies, Walmart sells it all cheap.
    A big chain with purchasing power can do much better than I.
    Energy costs are more likely a money pit for a restaurant.

  4. You all make some good points and I basically agree. “Unfortunately”, however, many people have money that isn’t accessible for buying gold/PMs (real money), emergency food, guns, arable land, or even to give it to others. Money in 401ks for example. Just as I never counted on receiving SS, I’m not sure I’ll ever see my 401 k savings either. It’s literally being held captive by a financial institution under the thumb of the federal government, and I can’t even borrow against it. So, to me it’s practically play money in a limited arena. I’m not adding to it any more, but I might as well try to make it grow just in case we’re all deluded and a new golden age of King Dollar and economic growth is just getting started that will make the 90’s look like the middle ages. You know…just in case. (Have you heard that consumer sentiment is at a 3-year high!).

  5. Why would you short ANY equity in this environment? Why would you BUY? Ben Bernake owns the store, and he’ll price each item at whatever the hell he wants to. You’re better off trying to learn how to count cards in blackjack at a casino.

  6. It all boils down to disposable income – who has it, how much of it, how long it will last. Employment, in other words.

    My take? No offense to anybody who works in these ‘service’ industries, but it wouldn’t bother me a bit to see a lot more cooking at home…

    And perhaps as well, a good old-fashioned cup-of-mud served up from home; the poking-away-at-iPads Starbuck’s metrosexual contingent, notwithstanding…

    Personally, I’d worry more about putting my existing greenbacks towards food and perhaps even fuel and a few other necessities at this point. We are approaching the surreal. That should be reason enough.

    If food prices begin to escalate beyond a yet-determined-by-the-feds level of public acceptance, any opportunities aimed at gaining from ‘opportunity’ will be dealt with in a manner not-so-friendly for those seeking to ‘profit-from-misery’.

    You didn’t discount the fed’s ability to subvert the laws of economics; so then, do not discount also, their ability to discount your ability to profit from it.

  7. My sister works for Olive Garden as a manager. About 1.5 yrs ago, I asked her the question, “What would the restaurant would do if food prices increased?” She said that they grew their own food…blah, blah, blah. I just tune her out when she starts talking about Olive Garden because she works 60-70 hrs there and has no outside interests other than msmedia crap. So, I can ask again if you all would like, so I can get an update.

    Chipotle is pretty healthy and I believe that people will pay a little extra for it for awhile.

    IDK…They all might close if/when the dollar fails, so I could be wrong.

  8. From my point of view, it does not make sense to short anything. Even if you make 50%, if the dollar falls 50% all you’ve done is break even. (Maybe double short) And have no doubt, the dollar will fall a lot. Ignore the fact that the dollar index is holding its own. All that is is against a basket of currencies, so the dollar is holding its own against those. But the surge in gold and silver in U.S. dollars tells me that the dollar is falling, and a lot. All currencies are falling against gold and silver, and the fall for the dollar will be very great due to all the supply which is largely right now sitting in Asian sovereign reserves. I suggest silver and gold!! Various other commodities – rice, perhaps zinc, foods

    1. Don’t knock shorting, it’s a beautiful thing! You get more dollars at a time when those dollars can buy more of the thing you’re shorting. You’re earning an asset (dollars) precisely at the time when it’s appreciating. For example, suppose you’re short the stock market when it halves: you get your capital back + 50% from that trade. But that original capital can now buy you the stock market twice over! And you get another 50% (which can buy you the stock market). But the best part is that everyone else is losing dollars; meaning you can out bid them at the porsche garage.

  9. I understand your logic. The inverse-ETFs I bought on Friday was an “impulse”. We shall see how it works out.

  10. I’ve been burned too many times lately betting on what makes sense, although I did “invest” in a few broad-market inverse-ETFs on Friday since new market highs were reached amidst geo-political turmoil (but now I’m feeling nervous because that put sort of makes sense!).

    Nevertheless, JR makes some good points, but the timing may be tricky. Also, I suppose it depends in part on the revenue distribution of any given company. If most of it comes from overseas then the inflation factor may be a wash if the developing countries revalue their currencies or continue to subsidize wholesale food prices. On the other hand, the drop in demand may be the biggest factor. I just don’t have much of a personal sense of fast-food consumption. I don’t eat it much myself, and those who do seem to be classic intractables. (What’s the supply-demand curve of a fast-food addict?)

    I read a number of articles and “alerts” this weekend predicting the near-term rally of the US dollar. I also read an equal number predicting its crash. Both made sense. Given this market, probably neither will happen.

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