One of the biggest factors affecting the restaurant and retail industries is the financial health of consumers. This raises the question: How does the health of consumers play into expectations for these industries going into 2023? Two directors from Fitch Ratings who focus on restaurants and retail discussed this question at this year’s ICR conference.
Softening Consumer Health and Sentiment in Retail
David Silverman, a senior director who heads up retail coverage for Fitch Ratings, believes it’s clear that we’re seeing some signs of softening consumer health and sentiment. “However, what’s important to remember is that we have been at historically strong levels when it comes to unemployment, wage growth, consumer savings and home equity growth,” he said. “So the consumer is likely to remain quite healthy, even if a little less so than the past couple of years.”
Silverman’s macroeconomic team is forecasting a very mild recession in the spring and summer of 2023. “However, this recession is not forecasted to be consumer led, nor is it expected to be particularly impactful to the consumer,” said Silverman. “We see overall consumer spending being flat this year compared to 2022.”
More specifically, Silverman expects retail volumes to decline in the low to mid-single digits across most retail categories. “For some context, we have to remember that retail sales in 2022 were probably about 30% higher,” he said. “We are expecting consumers to shift their budget and their time focus back toward services like travel and entertainment as we saw through much of 2022.”
Silverman believes that economic challenges are more likely to hit lower-end retail consumers. “They have enjoyed fewer of the economic benefits over the last couple of years and inflation is more impactful to their budget,” he said. Luxury remains quite strong across many goods and service categories.
“We’ve also got robust omnichannel models now, which means that retailers can reach customers in new and different ways,” said Silverman. “Customers may have more convenient access to cheaper alternatives to goods, which can make the trading down phenomena look a bit different than in prior cycles.”
Restaurants Benefit from Consumer Preference Shifts
Craig Sabatini, a director and primary rating analyst who heads up restaurant coverage for Fitch Ratings, said the restaurant industry has largely recovered from the pandemic. “I think restaurants benefited from the shift of consumer preferences toward services [away] from products,” he said. “If we look at our expectation for revenue this year, we’re projecting in the low single digit percent range, driven by some modest volume declines offset by price increases.”
If there’s a recession this year and a big pullback in discretionary consumer spending, Sabatini views it along the spectrum of the most value-oriented QSRs to the more premium QSRs to casual dining to fine dining. “If you looked at Burger King’s and McDonalds’ most recent earnings, their volumes were flattish,” he said. “They have value offerings on the menu and their revenues were up 10%, driven by price increases.”
When it comes to casual dining, Sabatini noted that Darden and Dime brands like Olive Garden and Applebee’s are performing well now. “But I think this type of restaurant catering to middle income consumers is where we might see a pullback in volume,” he said. Moving up to fine dining, these restaurants are also performing well. “I think this is where we could see rising prices,” said Sabatini. “These consumers have the ability to absorb higher prices so those volumes will be resilient.”
Inflation and Supply Chain Outlook
Rising inflation and tight supply chains have been big issues for restaurants and retailers over the past couple of years. Silverman and Sabatini shared their thoughts on how these will factor into the equation in 2023 and how they will impact operating margins.
Sabatini distinguishes between three different types of inflation for restaurants: commodity or food inflation, labor inflation and build inflation, or the increased cost to construct new locations. “Some commodity or food prices have increased 15% to 25% over the past year,” he said. “But a lot of restaurants didn’t pass this along to consumers, either because they have a value proposition of being a value offering or because they waited to see what their competitors did. So their margins were very compressed.”
We have a full year of prices increases coming into 2023. “So right off the bat, that’s going to buoy restaurants’ margins and we already see commodity inflation coming down so that will be a tailwind,” said Sabatini. Labor inflation, meanwhile, is the number one challenge faced by restaurants. “A lot of the workforce left hospitality during COVID and hasn’t returned,” said Sabatini. “Some think there are better alternatives with the gig economy to find work.”
Silverman believes there’s a “chicken and egg” discussion to be made when it comes to retail inflation levels and demand. “We’ve taken the view that the incredibly high levels of demand for goods that we’ve seen since the onset of the pandemic has caused a lot of the current inflation given limited production and supply chain capacity throughout the global supply chain,” he said. “Inflation to some degree has been a corrective mechanism to the high levels of demand that we’ve seen over the last couple of years.”
Silverman is seeing evidence that supply chain challenges are reversing and could actually be a benefit to retail margins in 2023 as costs come down and there’s less need to expedite shipping for orders because the global supply chain has relaxed. “And retailers have ratcheted down their inventory ordering, which should support profitability in that channel,” he said.
Get more insight on what’s in store for restaurants, retail, and a variety of other sectors for 2023 on the ICR Insights blog.
