The 2006 FER E&S Market Forecast

Another Year Of 2%+ Real Growth Predicted, But Slowing Operator Growth, More Price Pressure Expected
Some clouds are on the horizon, but Foodservice Equipment Reports forecasts real growth of 2.1% for foodservice equipment, supplies and furnishings manufacturer sales in 2006. While this is nearly half a point below the revised 2.5% forecast for '05, it does signal that the current market expansion should continue well into the coming year.

In this Fortnightly Special Report, we'll outline some of the trends behind the forecast. At the end, an PDF file with the forecast is available for download.

Current E&S Market
Most E&S manufacturers in North America have had very good years during '05, at least on the sales front. Profits are something else, as high prices for key materials remain a problem.

The NAFEM Sales Index through the first half, the MAFSI Business Barometer and the numbers from leading public E&S companies through the third quarter all show strong revenue gains in '05, at least on the equipment side. Growth of supplies categories has been somewhat more restrained and has led us to revise our forecast of their growth downward, affecting the total industry numbers. Our '05 forecast now stands at 2.5% real growth for the total industry. That total incorporates equipment, up 2.8% real, and supplies including tabletop up 1.9%.

Nominal growth with the aggressive price increases most manufacturers attempted to put through in '05 stands at 6.7% for equipment, 4.9% for supplies and 6.3% total.

Most of what we have heard anecdotally for the fourth quarter is that the market continues to slow gradually.

Operator Environment
According to Technomic Inc., NPD Foodworld, National Restaurant Association's "Restaurant Performance Index" and other sources, operator sales and traffic have slowed and even gone negative in some cases.

Two separate up-and-down cycles appeared this year, each tied closely to the run-ups in gasoline prices—the first in spring, the second following hurricanes Katrina, Rita and Wilma.

But the surprising thing is commercial restaurant sales have held up better than one would expect given the shocks to disposable income. And operator spending on capital goods, including equipment and supplies, has kept pace or even outperformed current sales growth, according to the NRA surveys.

Technomic's latest estimate of '05 real sales growth for restaurants and bars is 2.7%. And the firm estimates similar decent growth for its "beyond restaurants" segments.

The NRA Performance Index and its components have taken hits recently, with the overall index hitting a 27-month low last month. But many restaurateurs were still dealing with the post-hurricane fallout then, and sales appear to be recovering.

Where We Are In The Business Cycle
We'll let the macroeconomic detail go for the moment, other than to say leading economists expect somewhat slowing real growth next year, with real gross domestic product forecast at about 3.3%.

The foodservice and E&S cycles are somewhat different from the macro cycle and fall into three sections, or waves: The commercial chain cycle generally appears first and often serves as a leading indicator for the other two; street operator business follows; and big institutional business, the specification market, tends to be the last and latest mover. Both operator and E&S cycles follow this pattern with at least a six month lag for E&S. A big operator sales and traffic falloff, such as we saw in '01, can short circuit the E&S cycles.

The chain expansion is long in the tooth now, having begun in July '03. And sure enough, larger chain same-store sales and traffic have been moderating.

The street operators got hit hard by the gasoline price run-ups as well as inflation of important commodities including key foodstuffs. But they were spending for E&S in '05, as reflected in many dealers' strong sales. If street operators see sales come back up, they'll have some unfulfilled capital needs to look after. Many held off replacements during the '01-'04 downturn.

As for the third wave, the spec market is still going strong, from what we hear. The school market was better this summer than in years. The only question here is whether any decline in retail sales (and therefore tax revenue) might lead to some public budget cuts.

Look at it all, and it appears there is life left in this expansion cycle.

Price Outlooks
Until the hurricanes, it appeared the intense pressure on key commodities used in foodservice equipment and supplies was moderating, except for petroleum-based materials like plastics.

But that outlook has changed somewhat. Purchasing magazine's forecast for 304 stainless sheet has the key material's price rising back toward $2,500/ton with surcharges over the course of next year. And while plastic resins prices may moderate a bit, now that oil prices are coming down some, they are still running at very high historical levels.

And these price pressures come after most manufacturers couldn't raise prices enough in '05 to cover the huge cost increases that developed during the '03-'04 run-ups. Auto Quotes' calculation of blended '05 list price increases through June 1 was 5.38% and that's list, not incorporating "deviated" pricing many chains and buying groups enjoy.

So while a few months ago, we would have thought most '06 price increases would be in the 2% to 4% range, now we think 4% to 6% increase requests are more likely.

The 2006 Forecast Rationale
Put all this together, and John Muldowney of Clarity Marketing, who helps prepare these forecasts, and I see a slowing market for foodservice equipment, supplies and furnishings next year, but one still managing decent real growth of 2% or more. Nominals will probably still be fairly strong, as manufacturers go for the higher range of price increases to recover some of their cost increases.

From a segment standpoint, primary cooking products will still show the strongest growth. Big chain suppliers are benefiting from strong Yum! and McDonald's growth overseas, especially in Asia. And both street operators and big institutions are still spending in cooking equipment. Serving equipment and stainless custom fabrication, much of which goes into serving areas, will benefit from the back-end strength of the spec markets. Other segments reflect the slowing growth trend, but all remain positive.

Supplies will continue to show less robust growth than equipment, though trends are still positive. In part this reflects ongoing trends, such as the growth of quick service and its use of disposables instead of permanent ware. And this less robust growth also ties in with the slower pace of operator sales growth forecast by Technomic—which has '06 operator sales real growth off more than half a point from '05 performance.

There are some downsides risks, including an unforeseen crash of retail sales and consumer spending. But with oil prices moderating again, our best projection is another year of positive real growth