The restaurant industry finally seems ready to show improvements in
the second half of 2011. Riding on the back of a slowly reviving
U.S. economy and the consequent rise in comparable-store sales,
restaurant operators have managed to post improved results in
recent months. We expect restaurant companies to continue
delivering better numbers in the upcoming quarter over the
year-earlier period.
A recent survey by the National Restaurant Association revealed
that the Restaurant Performance Index (RPI), measuring the health
and outlook on the U.S. restaurant industry, was 100.7 in February,
up 0.4% from January. The RPI gain in February connotes
improvements in same-store sales and customer traffic.
The Current Situation Index, which measures comparable-store sales,
traffic counts, labor costs and capital expenditures in the
restaurant industry, was 99.4 in February, up 0.9% sequentially.
The Expectations Index, which measures restaurant operators’
six-month’s outlook on the above indicators, stood at 101.9, up
slightly from 101.8 in the prior month. Restaurant operators’
capital spending plans rose to the highest level in 40 months
reaffirming their optimistic outlook on the industry.
Going Forward
Looking ahead, we see solid top-line trends. International travel
to the U.S. also continues to grow. We believe well-positioned
companies will drive above-average traffic trends and enjoy pricing
power, leading to same-store sales increases in 2011. The economy
is continuing to improve, albeit at a modestly lower rate, but a
sluggish labor market, over-supply of restaurants in the industry,
higher gasoline prices and food cost inflation may weigh on
industry profitability.
Restaurants have been trying to win back cash-conscious guests by
revamping promotions, offering discounts and focusing on
value-for-meal menus. However, the tendency to offer discounts has
been moderating. We remain cautiously optimistic over the
near-to-medium term, with consumers continuing to look for value,
distinct dining experiences, as well as convenience and enhanced
menu deals in a gradually improving economic backdrop.
Drivers of the Restaurant Industry
The U.S. restaurant industry consists of Quick Service Restaurants
(QSR), Midscale Restaurants, Casual Dining, Non-Commercial and Fine
Dining/Upscale restaurants.
In the midst of what is considered to be a moderate recovery, there
are three potential drivers of net income growth for the restaurant
industry: unit expansion, same-store sales, cost-containment
efforts and marketing tools.
Unit Expansion: In response to an economy that lacks
luster, most of the companies have slowed their pace of restaurant
openings. However, with the expected resurgence of consumer
confidence, companies are turning back slowing to unit expansion,
though not aggressively.
BJ's Restaurants Inc. (BJRI) plans to open 12 to
13 restaurants in fiscal 2011 compared with 10 restaurants in
fiscal 2010. In the long run, there still exists room to open at
least 300 outlets.
Chipotle Mexican Grill Inc.
(CMG) plans to open 135–145 new restaurants in 2011, maintaining a
growth rate of 13%.
In fact, the companies are set to explore international markets.
While Chipotle is primarily concentrating on European countries
including U.K., Germany and France,
Buffalo Wild Wings
Inc. (BWLD) will expand its overseas footprint by opening
more than 50 company-owned and franchised restaurants in Canada
over the next 5 years. Another restaurant,
P.F. Chang's
China Bistro Inc. (PFCB) has also eyed the Canadian
market.
Darden Restaurants Inc. (DRI) announced a formal
area development agreement with Americana Group to spread its
operations in the Middle East. Several food chains including
Denny's Corp. (DENN),
Pollo Tropical of
Carrols Restaurant (TAST) and
Starbucks
Corporation (SBUX) intend to tap the fast-growing Indian
market.
McDonald’s Corp. (MCD) and
Yum!
Brands Inc. (YUM) already have considerable coverage in
India. Companies like Yum! Brands, McDonald’s and
California Pizza Kitchen (CPKI) are aggressively
expanding in China to capitalize on the fast-paced economic growth
in Asia.
Same-Store Sales: The second driver consists of menu price
increases and traffic counts. Restaurant operators reported
positive same-store sales and customer traffic growth in recent
months. Growth in menu price has accelerated, as per figures from
the Bureau of Labor Statistics. However, we remain cautious about
same-store sales growth in the months ahead due to rising food
costs and the consequent increase in menu prices, which could
detract traffic.
Cost-Containment Efforts: Some cost cuts have been
achieved through integrated information systems, including
point-of-sale, automated kitchen display, labor-scheduling and
theoretical food cost systems.
Marketing Tools: Social media as a marketing tool has created
ripples in the industry. As per National Restaurant Association, 8
out of 10 operators support the view that social media will become
an important marketing tool in the future. Hence, they are likely
to incorporate Facebook, online review sites, Twitter and blogs
into their marketing mix over the next two years.
OPPORTUNITIES
With the economic outlook improving, the fortunes of a number
industry players have turned around. These companies promise
long-term growth opportunities.
- Buffalo Wild Wings (BWLD) offers investors one
of the strongest growth stories in this space. Buffalo Wild Wings
had also been able to consistently deliver positive comps during
the height of market turmoil.
- With consistent earnings and a healthy balance sheet,
McDonald’s Corp. (MCD) provides relative safety
and moderate growth opportunities in the current scenario, as well
as exposure to faster-growing international markets. McDonald’s
U.S. comparable-store sales have been showing continued uptrend
since the last few months on strong sales of beverage as well as
core menu products.
- Boasting a unique position in the hyper-competitive bar and
grill segment, yet another stock, BJ’s Restaurants
(BJRI) offers investors a strong growth story with a viable
business strategy and debt-free balance sheet. The company
delivered impressive fourth quarter results in terms of earnings
per share and same-store sales growth.
Improved Californian Market
The core California market, which was badly hit by the recession
resulted in a high rate of unemployment and weak consumer
confidence, has started to turn around. We see plenty of growth
opportunities in the California and Texas markets.
Job Growth in the Sector
The restaurant industry is the major contributor to job growth in
the U.S. According to the National Restaurant Association, Texas
and Florida will likely show the strongest job growth over the next
10 years. As a point of reference, McDonalds itself plans to hire
as many as 50,000 workers on April 19.
Key to Success
Additionally, restaurants are accessing different means to plug the
problems of heightened competition in a somewhat over-supplied
domestic market. Companies continue to reduce their energy
consumption and are remodeling their restaurants to give an
up-market feel. They are rolling out new, smaller prototypes to
augment the perception of value and drive traffic thereby reducing
construction and occupancy costs to enhance returns on capital.
While Darden has embarked on an extensive remodeling plan for its
core brands like Olive Garden and Red Lobster to spur their
same-store sales, Chipotle Mexican Grill is introducing typical
Southeast Asian cuisine coupled with naturally raised food, for
which it is well known. Chipotle is trying to check how its model
works with other cuisines. If successful, we believe, the company
will execute the idea on a broader basis. Chipotle was also
unruffled by the economic slowdown. The company is well positioned
to expand rapidly while generating improved earnings, margins and
returns on invested capital.
The introduction of small plates or individual appetizers by
several chains such as California Pizza Kitchen, BJ's Restaurants
and Buffalo Wild Wings has already tasted success. Limited Time
Offers are also on the rise following the success of Buffalo Wild
Wings and
Red Robin Gourmet Burgers Inc.
(RRGB).
Additionally, most of the companies are transforming to more a
franchise-centric model to reduce the volatility in earnings and
increase cash flow generation. However,
Panera Bread
Co. (PNRA) bread is slightly more inclined toward
company-owned unit openings, which speak of the company’s
fundamental strength and makes us optimistic on the stock.
Breakfast Menus a Key Driver
Breakfast has accounted for nearly 60% of the U.S. restaurant
industry and remains a key driver of traffic growth in recent
years. Over the past five years, morning meal traffic has increased
at an average rate of 2% per year, while lunch visits were flat,
and supper traffic declined 2% per year on average.
We can thereby conclude that growth potential remains mainly in the
QSR markets. Leveraging the trend,
Wendy’s (WEN)
has expedited its new breakfast menu in different markets. The
company targets to have about 1,000 restaurants serving its new
breakfast by the end of this year.
According to an analysis by NPD, which has a ten-year projection of
foodservice trends based on aging, population growth and trend
momentum, servings of breakfast sandwiches are projected to outpace
the industry’s growth forecast. Annual servings per capita of
breakfast sandwiches at foodservice are expected to jump from 11 in
2004 to 14 in 2019.
Currently, there are a number of stocks in the restaurant industry
universe with a Zacks #1 Rank (Strong Buy). These include
Einstein Noah Restaurant Group Inc. (BAGL) and
Red Robin Gourmet Burgers (RRGB). Stocks like
Brinker International Inc. (EAT),
Yum!
Brands Inc. (YUM) and
Buffalo Wild Wings
Inc. (BWLD) currently retain a Zacks #2 Rank (Buy).
WEAKNESSES
Higher Food and Gasoline Prices
Food costs account for about one-third of restaurant sales.
Wholesale food prices have been on the rise this year. Prices of
corn, wheat, coffee and other commodities have also trended up
mainly due to a decline in the U.S. and Russian production
prospects, compelling many restaurants to raise prices on some of
their products.
The U.S. Department of Agriculture expects the average price of
food in 2011 to be 4% higher than the previous year. Food prices
rose 3.9% in February this year, primarily due to strong winter in
some of the highly fertile Southern states, such as Florida and
Texas.
It was a difficult season even at the wholesale level, recording
the highest price increase in 36 years. Additionally, after the
tragic earthquake and tsunami in Japan, prices of corn have
escalated further. Dairy and beef prices witnessed a steep rise on
a year-over-year basis.
With more expensive food and a spike in gasoline prices, people
will have less disposable income and prefer to dine at home. In our
pinion, most of the restaurants will try to safeguard their margins
by passing the cost hike onto consumers. While big and established
chains like McDonalds, Yum!, Starbucks will survive the price
increases due to their broad customer base and larger economies of
scale, smaller chains will feel the heat of rising commodity
costs.
Steep Competition and Promotional Offers
Competition among casual dining restaurants is expected to remain
fierce with respect to price, service, location and concept in
order to drive traffic. Environment is still value-sensitive. High
discount rates applied to menu prices in order to battle difficult
economic conditions are resulting in price wars among competitor
companies.
Hence, the failure of any promotional offer will put pressure on
the company’s same-restaurant sales growth. Dishes featured in the
Olive Garden promotion, especially in February, failed to be
accretive to the company’s growth leading to flat same store sales,
1.5 percentage points below its own estimate.
Shut Down of Regional Restaurant Chains
The majority of independent U.S. restaurant units are closing,
while chain restaurants remained steady. Large national chains,
which attract mainly higher-income visitors are performing better
than regional restaurants as upscale-customers are recovering
faster than the lower-income group.
Lag in Traffic Growth Barring Fast Casual
Restaurants
According to a recent NPD foodservice market research report,
visits to the leading fast casual restaurant chains grew 17% over
the last three years while the rest of the industry experienced its
steepest traffic declines. However, fast casual unit availability
increased 12% since 2007. Visits to the leading fast casual
restaurant chains, like Chipotle, Noodles & Company, and
Panera, were up 6% for the year ending December 2010 versus a year
ago. This compares with a 1% decline in total industry visits for
the same time period.
Given the lack of overall earnings catalysts, it is difficult to be
enthusiastic about a number of restaurant stocks. There are still
quite a few names with a lackluster outlook. These include
McDonald’s, Darden,
The Cheesecake Factory Inc.
(CAKE) and California Pizza Kitchen Inc., all of which retain the
Zacks #3 Rank (short-term Hold).
Ruby Tuesday Inc.
(RT) and
McCormick & Schmick's Seafood Restaurants
Inc. (MSSR) retain Zacks #4 Rank (short-term Sell).
Conclusion
The restaurant industry is not still immune to uncertainties in the
macro economy. Companies appear to be in a good position to take
advantage of an improved economy as evident from their capital
budgets. Easy comparisons from the prior year will likely place
this year's performance in a brighter light.
On the consumer front, while they were previously struggling to
survive in a recessionary environment, they are now grappling with
steeply rising commodity costs, a still-high unemployment rate and
dreary wage gains. These factors are still compelling consumers to
tighten their belts. In our opinion, a set of focused efforts will
help restaurant companies operate with a cautiously optimistic
outlook in 2011.
BIGLARI HOLDING (BH): Free Stock Analysis Report
BJ'S RESTAURANT (BJRI): Free Stock Analysis Report
BUFFALO WLD WNG (BWLD): Free Stock Analysis Report
CHEESECAKE FACT (CAKE): Free Stock Analysis Report
CHIPOTLE MEXICN (CMG): Free Stock Analysis Report
DENNY'S CORP (DENN): Free Stock Analysis Report
DARDEN RESTRNT (DRI): Free Stock Analysis Report
BRINKER INTL (EAT): Free Stock Analysis Report
MCDONALDS CORP (MCD): Free Stock Analysis Report
PF CHANGS CHINA (PFCB): Free Stock Analysis Report
RED ROBIN GOURM (RRGB): Free Stock Analysis Report
YUM! BRANDS INC (YUM): Free Stock Analysis Report
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