During 2013, every American will experience an increase in the payroll tax (which supports Social Security) to 6.2% from 4.2% on their first $113,700 of earnings. A 2% tax holiday had been enacted for 2011 and 2012 as part of an effort to boost consumer spending during a period of ongoing economic weakness. The cobbling together of the recent package to resolve the “fiscal cliff” put an end to this tax holiday. It should be noted that this was not a pure partisan issue. Neither Democrats nor Republicans were willing to support an extension.
The increase will fall hardest on those with the least. Certainly those earning $80,000 – $120,000 will be hurt but they have greater financial resources and thus greater capacity to adapt. Median income households are different. They will be forced to make adjustments. They must scrutinize how to allocate lower net pay among multiple competing uses, many of which are non-discretionary—and they have limited financial resources and so are less able to cope.
What this means is that discretionary personal spending must slow for all Americans, particularly for median income Americans. One area which will be impacted is dining out, particularly in non-fast food restaurants. An upscale restaurant will likely see some slowing but the average American presumably does not go there often. A company like Ruth’s Hospitality Group (NASDAQ: RUTH) may see some decline in customer traffic but its menu prices are high. It would be surprising to see high-end consumers making a dramatic shift in dining preferences based a rise in the payroll tax. Medium/high-priced restaurants are more likely to be hurt. Yet those at the low/medium end may indeed benefit. Consumers will always be looking for looking for good food, fair value, and great atmosphere. Restaurants which offer this combination have an opportunity to grow at rates in excess of the restaurant group as a whole.
One company which may be poised to seize this opportunity is Ignite Restaurant Group (NASDAQ: IRG). IRG owns two restaurant chains, Joe’s Crab Shack and Brick House Tavern + Tap. Wall Street buys into its story. Consensus estimates show estimated revenue rising from $405 million in 2011 to $467 million in 2012, $527 million in 2013, and $606 million in 2014. Diluted EPS estimates are $.62 in 2012, $.76 in 2013, and $1.05 in 2014. IRG closed at $12.96 on 1/11/13, about 17 times the 2013 consensus estimate and in line with the restaurant group as a whole. Yet it is showing higher growth.
The thesis for an investment in IRG rests on a growing revenue stream from opening more restaurants, not from growing same store sales. Same-store sales were up 3.0% for its quarter ending 6/18/12 but slowed to .4% for its quarter ending 9/10/12. IRG attributes the slower sales in its third quarter to a change in mix and slightly lower customer traffic. The payroll tax has the potential to change all that. Thus same-store sales may rise and boost revenue projections beyond those from new restaurant openings.
There are some issues though. Although Joe’s has been operating since 1991, IRG only went public in May, 2012. It lacks a clear track record as a public company. Furthermore, management may have damaged its credibility a bit with the restatement of earnings announced in July 2012. Yet the payroll tax hike will cause a change in all restaurants’ operating environment: IRG deserves a second look.