If you want to understand how high energy prices are impacting the economy, you could spend your days reading the Wall Street Journal or consulting with economists. Or you could go have a really expensive New York strip steak at the Palm or Morton's.
High-end steakhouses have expanded rapidly in recent years thanks to an economic expansion, the popularity of cholesterol-reducing statins such as Lipitor, and the low-carb/high-protein Atkins/South Beach diet crazes. You'll now find outposts of Morton's, Ruth's Chris, and several competitors in all the best suburban strip malls, edge-city shopping districts, and gentrified downtowns.
The financial results of these testosterone-filled cow palaces reveal much about several trends affecting the U.S. economy. First, they are a neat case study in the unexpected collateral effects of high energy prices. The high price of oil has spurred demand for ethanol, which in turn has boosted the price of corn. Corn is a primary "input"—or as we say in English, "food"—for beef cattle. (Here are charts showing the rising prices of corn futures and cattle prices over the last several years.) The combination of higher grain and energy prices has led to burgeoning inflation in food. In the first quarter of 2007, food prices rose at an annualized rate of 7.1 percent, according to the Bureau of Labor Statistics. Like many businesses, steakhouses face the classic choice of swallowing the higher costs—and accepting lower margins—or raising prices.
Some beef boîtes are boosting prices. The New York Times recently reported that "The Palm steakhouse chain has raised the price of its steaks by $2, and side dishes have gone up 50 cents to help compensate for the price of the beef." The company's chief operating officer told the paper: "I don't think our customers have noticed." (Note: If customers haven't noticed a sly price increase, you might want to refrain from broadcasting it to the New York Times'readers.) At Peter Luger, the Brooklyn landmark whose very name causes this writer to salivate, the price of the iconic porterhouse for two has risen from $79.90 to $81.
But most of the big meat chains seem to be eating the costs, as shown by their falling margins. At Morton's margins fell from 9.8 percent to 9 percent in the first quarter, thanks in part to rising costs. Ruth's Chris reported that first quarter 2007 operating income fell from 13.8 percent of revenues to 10.1 percent of revenues. Rare Hospitality, which owns 280 Longhorn Steakhouse outlets, saw first quarter 2007 operating income fall to 8.6 percent of revenues, down from 9.8 percent in the first quarter of 2006.
To aggravate matters, the rising cost of beef appears to be accompanied by slowing demand. At Morton's steakhouses, same-restaurant sales rose by a meager 0.5 percent in the first quarter of 2007. For the year, Morton's expects same-restaurant revenue growth of between 1.5 percent and 3 percent. When Ruth's Chris reported first-quarter sales in April, it reduced expectations of same-store sales growth substantially. At Rare Hospitality, same-store sales actually fell 1 percent in the most recent quarter. For the remaining three quarters of fiscal 2007, the company sees same-store revenue growth of between 0 percent and 2 percent for its Longhorn Steakhouse outlets. In each instance, same-store growth is rising at a rate slower than inflation.
Not surprisingly, given the shrinking margins and slowing revenue growth, the stocks of the major public steakhouse companies have done poorly in recent months. Here's a three-month chart of Morton's, Ruth's Chris, and Rare Hospitality compared with the S&P 500.
A look at the six-month chart of the same stock and the S&P 500 shows how the steakhouses could function as economic indicators. Note the outperformance in the first quarter and the underperformance in the second quarter. Steakhouses thrive on expense accounts. Their sales are tied to the exuberance of (mostly) men in the corporate world, and their business is largely discretionary. (It's easy to lose sight of just how expensive steakhouses are. At the Michael Jordan steakhouse in New York, for example, a dinner of shrimp cocktail [$16.50], New York Strip [$38.50], hash browns [$7.50], and creamed spinach [$8.50], plus dessert, wine, tax, and tip easily tops $100 per person.) Their outsized sales and stock performance in the early part of the year are lagging indicators, as bonuses are paid out and entertainment budgets are set based on the prior year's performance.
But as the year unfolds, steak stocks become more like leading indicators. If profits are humming, M&E budgets are in rude health, and prospects look good, you'd expect businesspeople to use steakhouses for meetings, deal-closing dinners, and recruitment lunches. When business slows down a lot—as it has in many sectors of the economy—it becomes much harder to justify a $250 lunch for three. Wall Streeters and hedge-fund guys may still be splurging for Kobe, but think about all those real estate and mortgage brokers, car dealers and consumer products salesmen, retailers and contractors who may be nibbling on takeout burritos because of slowing demand.
Right now, the steakhouse damage seems confined to the chains. The next trouble spot, however, could be the highest quality, most—um—rarefied steak joints. For decades, Peter Luger has been the epitome of high-end, high-quality, consumer-unfriendly steak: no credit cards, brusque waiters, and a remote location. So long as the economics of the steak business were friendly, the restaurant could afford to be standoffish. If the portly waiters in Williamsburg start wishing you a nice day and loudly tout the fact that Luger's proudly accepts the American Express card, start praying.