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Restaurants Make Guest Traffic Priority Over Profit Margins

(This story was originally published Friday.) By Annie Gasparro Of DOW JONES NEWSWIRES NEW YORK -(Dow Jones)- Menu board prices aren't rising as fast as those at gasoline pumps and supermarket aisles as quick-serve chains let profit margins take hits in the short term to protect longer-term market share. As they wrestle with higher commodity costs, fast-food leaders McDonald's Corp. (MCD) and Yum Brands Inc. (YUM), and quick-casual success story Chipotle Mexican Grill Inc. (CMG), say they don't plan to increase menu prices high enough to fully offset higher commodity costs. "We are willing to invest margin in the short term to continue to grow our business for the long-term," McDonald's Chief Financial Officer Peter Bensen said Thursday on a conference call. McDonald's expects commodity costs to be up 4% to 4.5% in the U.S. and Europe this year. Its restaurant-level operating margin in the first quarter fell to 17.7% from 18.2% year over year. McDonald's said that while it will raise prices some, it will do so slowly to avoid losing customers. "We plan to offset some but not necessarily all of the inflationary pressures with price increases, opting to take smaller increases over the course of the year to balance the impact on the consumer and our traffic," Bensen said. Corn futures have more than doubled since last summer, hitting a record high last week of more than $7.80 a bushel. For fast-food chains, the high price of corn spills into the cost of meat, as producers pass through higher feed prices and many trim the size of their herds, tightening supplies. Federal data show wholesale prices for lean grinding beef are up nearly 21% from a year ago to more than $2 a pound. Wheat prices have seen strong gains as well, with futures up 86% from last summer. The increases pressure restaurants that use flour for hamburger buns or tortilla wraps, but packaging and transportation costs typically have a larger impact on bread prices. Yum, with its Taco Bell, KFC and Pizza Hut brands, is also sensitive to hurting guest traffic. As a result, the fast-food operator said it is holding off on price increases, despite expecting some of the highest commodity cost increases. Yum estimates a 7% commodity cost increase in China and 6% in the U.S. "The bigger issue is what happens to the trends going forward because that's really going to influence what our pricing is and not necessarily what already occurred this year," Yum Chief Financial Officer Richard Carucci said Thursday on a conference call. "And we don't have a lot of visibility to that right now." Chipotle said that this summer, higher avocado prices alone will add about 0.5 to 0.6 percentage points to its total food costs, making food costs comprise 32% to 35% of its overall costs, up from 32% in the first quarter. "While our margins and financial results for the quarter were affected by higher food costs, which we have not yet passed along to our customers, we view this margin challenge as largely temporary and manageable over time," Chipotle Chief Financial Officer Jack Hartung said Wednesday on a conference call. The chain has said it plans to take price increases in the second half of the year to partially offset the rising costs. But given its use of fresher ingredients, Chipotle is often more vulnerable to commodity increases than other chains. Most restaurant chains are also burdened with the issue that they can't react as quickly to commodity fluctuations as supermarkets can, because they either only print their menus a couple times a year, or they to have to go through the red tape of getting franchisee approval first. As a result, the cost of eating at home is rising faster than that of eating out, pushing traffic from grocery stores to restaurants, especially fast-food ones. Earlier this year, the Food Away From Home index showed prices are up 1.5%, while the Food At Home index was up 2.1%, according to Jeff Bernstein, an analyst with Barclays Capital. McDonald's Bensen said the chain intends to keep menu price increases "below the food away from home growth rate, while also being mindful of what's happening at the grocery stores." Resisting menu-price increases "puts greater pressure on margins for restaurant operators," said Warren Solochek, restaurant analyst at NPD Group, during an online presentation. "But we don't ever expect restaurant operators to lead that process of taking price for the food industry, it would be foolish for them to do so." -By Annie Gasparro, Dow Jones Newswires; 212-416-2244; annie.gasparro@dowjones.com -Tom Polansek in Chicago and Curt Thacker in Kansas City contributed to this article.

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