The restaurant industry is finally showing improvements and seems
poised for long-term growth. 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.
In second quarter 2011, most big names in the industry outperformed
the Zacks Consensus estimates. More good news came from the NPD
foodservice market research report, which stated that annual visits
to restaurants are expected to increase by 8% over the next ten
years.
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 99.9 in May, down
1.0% from April. The slowdown in May was temporary.
For the first time in six months, the RPI stood below 100 in the
month. The RPI run-rate in the last six months 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 99.2 in May, down 1.1% from April. The
Expectations Index, which measures restaurant operators’ six-month
outlook on the above indicators, stood at 100.6, down from 101.5 in
the prior month. Restaurant operators’ capital spending plans are
also on the rise, reaffirming their optimistic outlook on the
industry.
Going Forward
Looking ahead, we see solid top-line trends. 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: Emerging from a lackluster economy, most
of the companies have accelerated their pace of restaurant
openings. With the expected recovery in consumer confidence,
companies are turning back 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 and McDonald’s 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.
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 of
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 (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 second 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. BJ’s Restaurants
and
Red Robin Gourmet Burgers Inc. (RRGB) are
expanding rapidly in California.
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.
Remodels and Menu Innovations Remain 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.
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.
Franchise-Driven Business Model
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) is
slightly more inclined toward company-owned unit openings, which
speaks to 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,
The Wendy's
Company (WEN) has expedited its 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 #2 Rank (short-term Buy rating). These
include BJ’s Restaurants, Buffalo Wild Wings, Chipotle, Darden,
McDonald’s.
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 companies are expecting industry-wide increases in commodity
and energy costs for fiscal 2012 as well. 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 will prefer to dine at home.
In our opinion, most of the restaurants will try to safeguard their
margins by passing the cost increases to consumers. While big and
established chains like McDonald's, Yum! and 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. The 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 from February to May failed to be accretive
to Darden’s growth, for instance.
Shutdown of Regional Restaurant Chains
A large number of independent U.S. restaurant units fell victims to
the downturn, while chain restaurants did relatively better. 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
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 that lack the earnings catalysts of their better
positioned peers. These include
Brinker International
Inc. (EAT), Yum!,
The Cheesecake Factory
Inc. (CAKE),
Einstein Noah Restaurant Group
Inc. (BAGL) and
Domino's Pizza Inc.
(DPZ), all of which retain the Zacks #3 Rank (short-term Hold).
Jamba Inc. (JMBA) and
Denny’s
(DENN) retain the Zacks #4 Rank (short-term Sell).
Conclusion
The restaurant industry is not 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 favorable 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 expected to continue weighing
on their spending behavior. In our opinion, a set of focused
efforts will help restaurant companies operate with a cautiously
optimistic outlook in 2011.
BJ'S RESTAURANT (BJRI): Free Stock Analysis Report
BUFFALO WLD WNG (BWLD): 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
MCDONALDS CORP (MCD): Free Stock Analysis Report
PF CHANGS CHINA (PFCB): Free Stock Analysis Report
PANERA BREAD CO (PNRA): Free Stock Analysis Report
RED ROBIN GOURM (RRGB): Free Stock Analysis Report
STARBUCKS CORP (SBUX): Free Stock Analysis Report
CARROLS RESTRNT (TAST): Free Stock Analysis Report
YUM! BRANDS INC (YUM): Free Stock Analysis Report
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