As consumers become increasingly cost-conscious and look to limit their spending on dining out, fast-casual dining chains like Chipotle (CMG) continue to record robust performance. Citi Director and Restaurant Analyst Jon Tower joins Yahoo Finance Live to discuss why he believes the fast-casual dining sector is a strong investment opportunity.
Tower describes fast-casual dining stocks as having "fairly strong momentum," offering high-quality food at affordable prices. He notes that their growth and opportunity in the US and internationally are in their "infancy," attracting a younger and wealthier demographic that will continue to boost growth. Specifically, Tower highlights YUM! Brands (YUM) as "unique," citing their expansions, global reach, and adoption of digitization across franchisees.
Addressing pricing strategies for these restaurant chains, Tower explains that their price pressures mainly come from food and labor costs. He notes that both food and labor inflation have decreased significantly in recent years. However, with regions like California implementing wage increases, Tower acknowledges that "brands will have to price to offset that."
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Editor's note: This article was written by Angel Smith
Video Transcript
JARED BLIKRE: The cost of dining out continues to outpace your weekly grocery bill. Meals at restaurants and bars cost diners 4.5% more compared to a year ago with restaurants honing in on price hikes due to persistent labor inflation. But despite those stubbornly high restaurant prices, our next guest is still bullish on fast casual names like Chipotle and Yum Brands.
And for more on the sector, we're joined now by Jon Tower, Citi director and restaurant analyst. So thank you for joining us here today. Break down your view for us on some of these faster restaurant names that you're covering.
JON TOWER: Yeah. Thanks for having me. So we're constructive on Yum, Darden, Chipotle, and a few others in the space. And effectively, there's a few things we like about them from the fast casual standpoint. We think that those businesses have fairly strong momentum, and what they're doing is carving out a category that sits obviously between full service dining and limited service dining, and attractive price point with higher quality food.
And those are still in their infancy in terms of where they are with respect to growth and the opportunity in the US and abroad. So we think that where they're hitting with the consumer right now, especially with respect to the demographics, they're hitting younger, they're hitting wealthier. That works really well.
And given the backdrop in the US at the moment where it appears as though the lower income consumer is cutting back quite a bit on their consumption away from home, perhaps pivoting to grocery as an alternative. We like brands that have momentum. You know, Yum Brands a little bit unique in that they're a global quick service operator.
We like them because frankly they continue to open stores across the globe. They're using franchisee capital to make this happen. And specifically what we like that's slowly emerging for them is this digital platform that they've built out, effectively creating capabilities for their franchisees that allow them to become more digitized across their system.
And Yum is going to be capturing more of that revenue back to themselves instead of farming it out to third parties as they previously did. And we think that's going to allow their franchisees to become more profitable, which will then fuel greater unit growth across the globe over time across the three major brands that they have. So those two Chipotle and Yum are right up there.
SEANA SMITH: Hey, Jon, I'm curious to get your perspective on the pricing strategy for Chipotle and Yum. How do you see that playing out going forward, given the fact that, yes, prices are obviously still higher than they were a year ago in many respects, but we're not seeing anywhere near the type of increases that we were a year ago.
JON TOWER: Yeah. I think the argument can be made that so long as employment and jobs continue to grow and wages continue to move in the right direction, particularly in the US, there is room for these restaurants to continue to take some modest pricing right in line with inflation. And you think about it, they're considering the cost-- the primary cost buckets are going to be food costs and labor costs.
And both of those-- food inflation has come down relative to where it has been in recent years, certainly labor inflation as well. However, they're still moving upward. And so the idea of these concepts going from, say, high single digit, in some cases, low double-digit pricing down to low single-digit pricing makes sense.
Now, obviously there's markets like California where wager rates are going to be shifting quite dramatically starting in April. And brands are going to have to price to offset that in the market. It's TBD in terms of how that plays out for demand. We're a little bit more nervous for brands that have overexposure there and haven't had strong momentum in underlying traffic going into this period of likely higher prices.
Could you see traffic drop off pretty dramatically in response to that? Yeah, you could. But those brands that have momentum, which means they've been giving a fairly strong consumer proposition for some time, typically good food on the plate and strong throughput, we think those brands are still going to outshine the rest of the category. That's your Chipotle, is a good example.