010544 Energy Costs Pressure U.S Fast-Food Industry

Chicago - Higher overall electricity costs and rolling blackouts in California may take a bite out of earnings for fast-food restaurants after rising natural gas and heating oil prices shaved profits last winter.

However, the impact on earnings remains an open question as officials at some of the major quick service restaurants say they are unsure how energy costs will affect the bottom line as the U.S. approaches the warmest months of the year.

Anyone with a large presence in California is at risk, with regional chains such as hamburger makers CKE Restaurants Inc. and Jack in The Box Inc. that are based in the state at a higher risk than more geographically diversified companies such as McDonald's Corp., Wendy's International Inc. and Tricon Global Restaurants Inc., said Damon Brundage, a Raymond James restaurant industry analyst.

“The companies have done various things to hedge their energy exposure, and as we switch away from essentially gas and oil heating bills in the winter to air conditioning, electricity, in the summer, energy costs may moderate a little,” Brundage said.

Even with diversification, energy costs have affected the larger companies overall “and I expect there will continue to be (an impact) in the second quarter,” he added.

McDonald's Corp. executives said at the company's annual shareholders meeting on Thursday that rising energy costs were pressuring margins at the fast-food giant throughout the United States and they are taking steps to address the impact.

California has been plagued by chronic power shortages, and faces sharply higher electrical rates, as a flawed 1996 deregulation law forced utilities to absorb wholesale price increases instead of passing them on to customers.

Power shortages are expected to worsen over the summer, but have had a negligible impact so far, restaurant officials said.

LOW MENU PRICES GIVE LIMITED WIGGLE ROOM

Given relatively low menu pricing in a typical fast-food restaurant, energy as a percentage of revenues doesn't have to rise a lot to erode margins, and the industry is limited in raising prices to offset the pressure, Brundage said.

Several fast-food companies have cited rising energy costs as a drag on earnings, including Wendy's, the No. 3 U.S. hamburger maker, and Louisville, Kentucky-based Tricon, the world's No. 2 fast-food company with more than 30,000 company-owned and franchised restaurants.

Wendy's said higher energy, labor and beef costs cut into first-quarter profits. Tricon, operator of the Taco Bell, Pizza Hut and KFC fast-food chains, said first-quarter overall margins were flat in the United States as particularly high energy costs offset strong sales.

Rising energy costs have rippled through the food industry from growers such as fruit and vegetable giant Del Monte Foods Co. to grain processor Archer Daniels Midland Co. and are expected to be a factor the rest of the year.

ENERGY COSTS A DOUBLE-EDGED SWORD

Gasoline and electricity costs may be a double-edged sword as they raise fast-food restaurant expenses and squeeze the discretionary income from customers, Bear Stearns restaurant analyst Joseph Buckley wrote in a recent report. He said on Thursday those issues remained valid.

Buckley wrote that costs have the potential to worsen if projected beef price increases play out. Higher labor costs also remain unabated, and utility costs have been cited frequently as a significant pressure on margins, he wrote.

Jack in The Box has been pressured by natural gas and electricity costs overall, not just in California, which has about 750 of the San Diego-based chain's 1,700 restaurants, spokeswoman Karen Bachmann said. Electricity costs are seen as a bigger factor in the second half of the year, she said.

Utility costs that include water, electricity and natural gas grew to 3.2% of second-quarter sales from 2.5% a year ago and are expected to rise to 3.5% to 4.0% of sales in the fiscal second half, Bachmann said.

Jack in The Box raised prices by 1.8% in the first two quarters and expects to increase prices another 1% in the second half of the year to offset costs, Bachmann said.

In a research report on May 9, Salomon Smith Barney analyst Mark Kalinowski wrote that rising utility costs may reduce Jack in The Box's third-quarter earnings by 5-6 cents per share.

CKE, which runs Hardee's and Carl's Jr. restaurants, has seen little impact in California, but, “We have to plan for the worst and be pleasantly surprised when it doesn't happen,” said Loren Pannier, CKE senior vice president of investor relations.

Natural gas prices have pinched company-owned Burger King Corp. restaurants, located east of the Mississippi River in the United States, spokeswoman Kim Miller said. Burger King is the second largest U.S. hamburger chain behind McDonald's and a unit of British conglomerate Diageo Plc

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