Morningstar - Q1 2024 - 59

Restaurant Revolution
New technology could reshape
the industry.
SECTOR RAP
Ivanna Hampton
Here's something to chew on: Innovation could
remake the restaurant industry within the next
few years.
For decades, restaurants had very little reason
to invest in innovation, given that they had
cheap labor, thin margins, and scant customer
data, says Sean Dunlop, who covers the industry
for Morningstar Research Services. Then the
coronavirus pandemic accelerated a tech evolution,
led to a worker shortage, and contributed to
higher food and labor costs.
" Consumers are starting to balk at price hikes
when they walk into a restaurant and realize that
a hamburger's not as cheap as it used to be, "
Dunlop says.
Now restaurants are looking to technology to
cut costs and build relationships. An AI-driven latte?
What about robot-crafted tortilla chips? Improved
digital ordering and revamped loyalty programs?
These are some of the developments that Dunlop
notes in his most recent restaurant technology
research.1
The industry could face some challenges
in 2024, but opportunities exist for investors who
want a taste of this sector.
I spoke with Dunlop on Dec. 6 for Morningstar's
Investing Insights podcast.2
Our conversation
reflects conditions and valuations as of that date.
It has been edited for length and clarity.
Hampton: Let's talk about artificial intelligence's role.
How can it speed up the tech evolution?
Ivanna Hampton: Why has the restaurant industry
trailed other industries in adopting technology?
Sean Dunlop, CFA, is a consumer
equity analyst for Morningstar
Research Services LLC.
Dunlop: We would look at three big ones.
Artificial intelligence can help with restaurants as
a cost center. It can help as a sales lever. And
then it can help with menu innovation. If you think
about something like automating inventory
forecasting, restaurants waste roughly a third of
the food that they purchase, sometimes more
than that. Even incremental improvements
can have a big impact on a restaurant profit-andloss
statement, particularly because food
costs are about 30% of total restaurant costs.
Sean Dunlop: For starters, the industry is
very reliant on cheap, abundant labor. About a
third of industry sales are tied to wages
and benefits, and that labor has only recently
grown expensive. As you look back to February
2019, wages in that leisure and hospitality
space have increased 26% to 27% relative to
prepandemic levels.
The second piece is thin margins. The restaurant
industry disincentivizes investment. As you look
at a fragmented industry with a lot of independent
restaurants, you're typically operating at lowsingle-digit
net margins. If I'm a mom-and-pop
coffee shop, how much am I willing to invest
to cut my inventory waste by 25% to 33%? In most
cases, it wasn't enough to justify an ROI in a lot
of these technology investments.
The third piece is data access, which has been an
issue really until recently. McDonald's MCD
only knew about 5% of its customers as recently as
2021 in terms of names, addresses, and unique
identifiers, when it rolled out its MyMcDonald's
rewards program.
As a sales lever, AI is already increasingly
integrated with loyalty programs. A lot of the
offers that you receive with push notifications are
spooky close to when you're thinking about
ordering dinner. That's an AI integration. It's
segmenting customers within a cohort that looks
a lot like them-when they might order a
meal. That's only liable to increase. Today, we see
about an 18% to 30% increase in guest frequency
for members of loyalty programs, and there
are several companies, like Starbucks SBUX,
that have more than half of their North American
sales coming from loyalty program members.
As for that third piece, menu innovation: AI
integration allows restaurants to see what sells
well, what sells well with what, and identify
consumer trends much more quickly than they
used to in the past. Think about Starbucks'
rollout of its cold foam cold brews, its nitro cold
brews, its whole line of Refreshers beverages.
That's something they might not have been
able to do in 2016, 2017, 2018. That's increasingly
accessible with its Deep Brew AI technology.
Hampton: You've written that restaurants can grow
their bottom lines without raising prices on customers
if they shift towards digital adoption. Explain how.
Dunlop: In 2021 and 2022, we saw massive price
increases for restaurants across the board, in
many cases, as much as the midteens as you look
back on a two-year stack. We're just getting
to a point where consumers are starting to balk.
The response that we would recommend
for restaurants in most cases comes from three
1 Dunlop, S. 2023. " Restaurant Technology's New Dawn Should Serve Astute Investors Tasty Opportunities. " Morningstar Consumer Observer. April.
2 Investing Insights is available on Morningstar.com, YouTube, and all podcast apps.
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