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Casual-dining trends continue to improve as customers gradually return to the restaurants, but the industry's recovery from more than three years of declining sales will likely run into some hiccups.
The bumpy road could interrupt a sizzling rally in shares of casual-dining stocks over the last several months, with some of the largest chain restaurants like Darden Restaurants Inc. (DRI), up 27%, Brinker International Inc. (EAT), up 30%, and DineEquity Inc. (DIN), up 64%, so far in 2010. High-end steakhouse operators Ruth's Hospitality Group Inc. (RUTH) and Morton's Restaurant Group Inc. (MRT) have both seen their shares more than double this year, as the premium dining segment has also stabilized.
The S&P 500 Index, meanwhile, is up 5% this year.
Same-store sales, a key measure, still remains negative overall in casual dining, though investors have bid up valuations hoping the long-awaited turn to positive territory will soon materialize. Knapp-Track, a closely watched index that tracks same-store sales at more than 10,000 restaurants, has declined each year since 2007, though the index appears to have bottomed last July.
Malcolm Knapp, who administers the survey, says Knapp-Track has begun to record some positive weeks, and will likely flip positive for a month sometime in the second-half of the year.
Better sales have mostly been factored into valuations, says Destin Tompkins, restaurants analyst with Morgan Keegan & Co., and shares will likely need even-rosier sales upsides to move higher. But, he said, "if it slows down and doesn't materialize as much as is expected, there definitely could be some downside."
The recovery is unfolding unevenly, with one common thread among the expected outperformers is a unique concept that allowed them to avoid significant discounts in the past year, analysts say. While less intense discounting is helping all, chains like Darden and Cheesecake Factory Inc. (CAKE) are finding their differentiated menus and experiences can stand out more without the din of deals.
The dichotomy is playing out among the largest companies. Last week, Darden, which refused to wade into deep discounting, reported a positive quarter of same-store sales at Olive Garden, Red Lobster and LongHorn Steakhouse for the first time in almost two years.
Brinker's Chili's Grill & Bar's same-store sales remain under pressure, falling up to 5.5% in its latest quarter, as the chain ended a promotion that offered two appetizers and a shared appetizer and dessert for $20. Brinker executives said Chili's sales are still "choppy," comments that underscore concerns about whether customers will only come in for deals.
"It certainly goes back to whether in the absence of discounts, how relevant are these concepts?" Stephen Anderson, restaurant analyst at MKM Partners LLC, said.
Better demand for eating out may eventually translate to upward pressure on commodities. The formula could set up the next challenge for the sector as chains try to pass along higher costs to the consumer. Once again, the differentiated concepts may get greater leeway from customers to raise prices.
"Ones that have discounted are going to have a tougher time of it," Anderson said.
-By Paul Ziobro, Dow Jones Newswires; 212-416-2194; email@example.com