Wendy’s, the famous fast-food chain, surpassed second-quarter earnings expectations. However, the company fell short on revenue when it released its results on Wednesday.
Following a familiar pattern, other major players in the industry like Starbucks, Domino’s Pizza, Yum! Brands, and Chipotle Mexican Grill also reported a similar trend: earnings exceeded expectations while revenue fell below.
For companies such as Domino’s and Starbucks, U.S. sales proved to be a challenge. While Domino’s experienced a 0.1% increase in same-store sales in the U.S., their international same-store sales saw a more promising growth of 3.6%. Similarly, Starbucks had a decline in North American same-store sales at 7%, compared to a 9% growth in the same quarter of the previous year.
The revenue misses came as a surprise to many investors, as the sector had been anticipated to perform well during earnings season. Prior to July 24, when Domino’s initiated the season for restaurant earnings, the AdvisorShares Restaurant ETF had already gained over 20% this year. However, since then, the ETF has dropped 5.3%, underperforming the S&P 500’s 1% gain.
UBS analyst Dennis Geiger suggested that the market’s slight negative sentiment towards these earnings results may indicate “increased caution in the sector due to likely decelerating sales trends in the second half.”
Restaurants have been a shining star in the consumer discretionary sector over the past year, as consumers have prioritized experiential spending over purchases of durable goods. Although there was an expectation for strong momentum in the first half of the year, analysts anticipate a slowdown in the second half.
The Changing Landscape of Earnings
The latest spate of earnings suggests that a slowdown in the economy may have occurred earlier than expected. As revenue growth continues to decelerate, investors are turning their attention to other financial metrics, particularly profit and margins.
Restaurants, thus far, have proven adept at navigating the market’s softness, consistently surpassing earnings expectations. This can be attributed to lower food and labor inflation, as well as the ability to implement price increases at the store level, resulting in robust earnings and margin growth this quarter.
The question now remains: can big-box and specialty retailers follow suit? Michael Baker, an analyst at D.A. Davidson, believes there is a possibility that the “earnings beat/revenue miss” pattern could persist throughout the remainder of the earnings season.
Contrary to popular belief, Baker sees this as a positive development.
“We need to see a slowdown,” Baker explains. “For the market to truly function effectively, the Federal Reserve needs to halt its rate hikes. However, the Fed will only do so if it is confident that inflation has cooled sufficiently and that the economy is stable. If all these retailers continue to outperform expectations and experience extraordinary sales growth, the Fed will be hesitant to stop raising rates.”
While consumer demand may indeed be slowing down, Baker is confident that it will not plunge the economy into a full-blown recession.
“To me, a soft landing is precisely what the market needs,” he concludes.
