The year 2010 will see a gradual improvement in the restaurant industry, which has faced extremely tough challenges due to the economic turmoil that resulted in weak labor and tight credit markets, and lower discretionary spending.
With the U.S. economy slowly reviving, we believe that easy comparable-store sales results and moderate costs will help restaurant operators to deliver better numbers in the current year compared to 2009.
Restaurants have been trying all means to lure cash-conscious guests. Consumers continue to be reluctant to shell out more — preferring to dine at home or spend less per meal. Eateries are tweaking entrées, revamping promotions and focusing on value-for-meal menus. We believe that consumers in 2010 will still be looking for value, distinct dining experiences, convenience and enhanced menu deals.
Although current economic indicators show some signs of improvement, we believe that the sluggish labor market will continue to be a headwind to growth in the restaurant industry. The downturn has shattered consumer confidence, and it will take time before most people resume their former dining-out habits.
The U.S. restaurant industry, which constitutes fast food, casual dining and upscale chains, has seen its toughest times in recent years. A report by market research firm NPD Group indicated that comparable-store sales trends are showing signs of improvement.
BJ’s Restaurants, Inc. (BJRI) recently in its first-quarter 2010 earnings results indicated that comparable-restaurant sales for the quarter grew substantially by 4.4%, on a drop of 0.2% registered in fourth-quarter 2009 and a decline of 0.1% witnessed in the prior-year quarter. The company also hinted that traffic remains in the positive zone for the first time since third-quarter 2007.
McDonald’s Corporation’s (MCD) U.S. comparable-store sales have been showing improving trends. After dipping 0.7% in January 2010, comps grew by 0.6% in February and then rose by 4.2% in March.
A recent survey by the National Restaurant Association revealed that the Restaurant Performance Index, measuring the health and outlook for the U.S. restaurant industry, reached its peak level of 99.0 (up 0.7% from 98.3 in January) in February 2010 since November 2007. Although the index remained below 100 for 28 consecutive months, it reflects the return of confidence in the business climate.
The Current Situation Index, which measures comparable-store sales, traffic counts, labor costs and capital expenditures in the restaurant industry, climbed 0.1% to 96.7. Approximately 57% of restaurant industry operators have reported comparable-store sales decline in February 2010, reflecting a similar percentage of decline in January. Moreover, 55% of the operators have reported a decline in traffic in February versus 54% reported in January.
The Expectations Index, which measures restaurant operators’ outlook on comparable sales, employees, capital expenditures and business environment, rose 1.2% to 101.4. Approximately 44% of the restaurant operators (up from 33% in January) now expect to have higher sales in 6 months compared to the same period in the last year, compared to 16% of restaurant operators (down from 22% in January) who expect lower sales in 6 months.
In the midst of what is expected to be a moderate recovery, there are three potential drivers of net income growth for the restaurant industry: unit expansion, improved same-store sales and cost cuts.
There seems little chance of any upside from aggressive unit expansion, as most of the companies have slowed their pace of restaurant openings in the wake of the economic downturn. BJ’s Restaurants plans to open 10 to 11 restaurants in fiscal year 2010. In 2009, the company opened 10 restaurants compared to 15 opened in 2008. Darden Restaurants Inc. (DRI) expects to open 50 to 55 net new restaurants in fiscal year 2010, drastically down from 71 restaurants opened in the last fiscal year.
The second driver, same-store sales, consists of menu price increases and traffic counts. Any price increases other than minimal ones would drive away value-conscious customers in this fiercely competitive environment. Moreover, to enhance the perception of value and to drive traffic, companies are remodeling restaurants to give an up-market feel, and are rolling out new, smaller prototypes that reduce construction and occupancy costs to boost returns on capital.
Finally, some of the cost cuts have been achieved through integrated information systems including point-of-sale, automated kitchen display, labor-scheduling and theoretical food cost systems. Restaurant companies try to optimize their operations and achieve decent operating cash flow margins. Over the last five years, Darden has kept its restaurant operating cash flow margins stable at 22%−23% despite the current economic headwinds.
OPPORTUNITIES
Despite the sluggish environment, there are defensive stocks in the restaurant industry that promises long-term growth opportunities. Buffalo Wild Wings Inc. (BWLD) offers investors one of the strongest growth stories in this space with an annual growth target of 13% to 15% in units and 20% in net earnings. Buffalo Wild Wings has also been able to consistently deliver positive comps even when the recession hit the economy.
With consistent earnings and a healthy balance sheet, McDonald’s (MCD) provides relative safety and moderate growth opportunities in the current scenario and exposure to faster-growing international markets.
Another stock, Chipotle Mexican Grill Inc. (CMG), has remained largely unruffled by the recent economic slowdown. The company is well-positioned to expand rapidly while generating improved earnings, margins and returns on invested capital. In fiscal 2010, the company plans to open 120 to 130 new restaurants, reflecting a growth of 12.6% to 13.6%. In fiscal 2009, the company opened 121 new restaurants and closed 2 locations, reflecting a net growth of 14.2%.
WEAKNESSES
Offsetting these opportunities in the restaurant industry are stocks that still lack sheen to an extent. Nearly 50% of Red Robin Gourmet Burgers Inc. (RRGB) and two-thirds of BJ’s Restaurants outlets are located in areas that have been hit hard by the recent housing downturn and economic slowdown. These include California, Arizona, Nevada, Colorado, Oregon and Washington. This may dampen the company’s growth potential.
The financial distress has engulfed all the business sectors, and the restaurant industry has not been immune, either. The recent global meltdown has rocked the restaurant industry and it will take time to completely come out of the woods.Zacks Investment Research
