Lamb Weston had a disappointing Q2: what the French fries economics is telling us?

French fries may seem like a simple side dish, but their demand reveals much about broader economic trends.

Recent data from Lamb Weston, the primary supplier of frozen potatoes to McDonald’s, highlights significant shifts in the fast food and broader economic landscapes.

The company’s latest earnings report underscores challenges that go beyond just fewer orders of fries.

French fry demand down as fast food traffic drops over 4%

Ordering French fries at McDonald’s appears straightforward, but it relies heavily on Lamb Weston, an Idaho-based company that grows, processes, and ships potatoes to McDonald’s.

Lamb Weston’s fortunes are closely tied to how many fries customers order. Recently, the company reported diminished traffic at fast food chains like McDonald’s, which experienced a more than 4% drop in traffic at hamburger specialty restaurants.

Despite a higher “fry attachment rate” — the percentage of customers adding fries to their orders — overall French fry demand has declined due to fewer customers visiting these restaurants.

Derived demand drives down potato orders

This situation exemplifies basic economic principles regarding demand. Economists understand that demand curves shift when determinants such as income, complementary and substitute products, the number of buyers, and utility change.

Here, McDonald’s diminished “income” from French fry sales translates into lower demand for Lamb Weston’s frozen potatoes.

This is a classic case of derived demand, where the demand for one good (frozen potatoes) is driven by the demand for another (fast food).

Lamb Weston’s revenue falls 5%, shares drop over 25%

Lamb Weston, an $8 billion global company, saw its value plummet after a disappointing earnings report.

The company’s revenue declined by 5%, and its earnings collapsed, leading to a bleak outlook.

Lamb Weston’s CEO, Tom Werner, attributed the poor performance to several factors, including targeted price investments, a voluntary product withdrawal to maintain quality standards, unexpected market share losses, an unfavourable product mix, and softer-than-expected restaurant traffic in both the US and key international markets.

Fast food price increases lead to shifting consumer behaviour

The core issue, however, is simpler: the performance of fast-food restaurants has been slipping.

According to Jake Bartlett, a restaurant analyst at Truist, recent weakness in fast food chains is primarily due to price increases backfiring.

Fast food price hikes have narrowed the value advantage, pushing consumers to either trade up to fast-casual options like Chipotle or down to grocery stores where price increases have been smaller.

This has significantly impacted traffic at fast food establishments.

Pandemic-induced disruptions and inflation impact restaurant margins

The pandemic caused significant disruptions in the restaurant industry, with initial lockdowns leading to a collapse in demand, followed by a surge as consumers spent their accumulated savings.

Supply chain issues further compounded the problem, leading to inflation and price hikes across the board. Restaurants, including McDonald’s, raised prices to protect their margins.

This is evident in McDonald’s operating margin, which increased post-pandemic but now faces challenges as consumer spending patterns shift.

Lamb Weston’s pandemic performance and future outlook

Lamb Weston thrived during the pandemic, with quarterly sales surging. This growth attracted investor interest, and between early 2022 and mid-2023, the company’s shares doubled. However, the increase in sales was primarily driven by price hikes rather than volume growth.

The CEO acknowledged this, stating that future sales growth would need to be volume-driven, focusing on selling more potatoes rather than increasing prices.

This strategic shift is critical as competition forces price cuts. Future revenue and profit growth for Lamb Weston will depend on increasing sales volumes, improving product mix, and achieving cost savings.

The reliance on price increases during the pandemic is no longer sustainable, necessitating a focus on selling more products to drive growth.

Inflation and supply chain issues persist

The Lamb Weston saga illustrates that the economic disruptions from the pandemic are still impacting asset prices. Inflation continues to resolve unevenly, with its effects still being felt.

The company’s recent financial performance shows the challenges of navigating economic disruptions in real time. Processing potatoes is a commodity industry, making companies like Lamb Weston price takers.

The pricing power gained during the pandemic was always temporary, and the current market correction reflects this reality.

Forecast for 2025: Net sales expected between $6.6 billion and $6.8 billion

Looking ahead, Lamb Weston forecast its annual sales and profit below analysts’ expectations, as higher prices of its frozen food products begin to hurt volumes.

The company has been increasing prices of its products, including ready-to-cook classic and sweet potato fries, to offset rising costs of manufacturing, transportation, and inputs such as potatoes.

Lamb Weston, which supplies to fast-food chains such as McDonald’s and KFC-owner Yum Brands, also faced pressure from more people opting to cook their meals at home amid persistent inflation. CEO Tom Werner stated,

Market share losses and a slowdown in restaurant traffic in the US and many of our key international markets were greater than we expected. We also incurred losses related to a voluntary product withdrawal.

The company forecast 2025 net sales in the range of $6.6 billion (€6.09 billion) to $6.8 billion (€6.3 billion), the mid-point of which was below LSEG estimates of $6.79 billion (€6.3 billion).

It also expects full-year earnings per share to be between $4.35 and $4.85, compared with analysts’ average estimate of $6.09. The company said its volumes in the first half of the fiscal 2025 were likely to decline in the low-to-mid single-digits range.

Quarterly performance: 8% volume drop and revenue below expectations

Lamb Weston’s volumes fell 8% in the fourth quarter. Revenue of $1.61 billion (€1.5 billion) in the quarter ended May 26 was below analysts’ estimate of $1.70 billion (€1.6 billion).

The company’s adjusted earnings per share was at 78 cents compared with the $1.26 estimated.

The demand for French fries offers a unique lens through which to view broader economic trends.

Lamb Weston’s recent financial struggles underscore the ongoing impact of pandemic-induced disruptions on the fast food industry and the broader economy.

As the company adjusts its strategy to focus on volume-driven growth and cost management, it faces a challenging path ahead.

The economic landscape continues to evolve, reflecting the complexities and uncertainties of a post-pandemic world.

The post Lamb Weston had a disappointing Q2: what the French fries economics is telling us? appeared first on Invezz