With the onset of spring, the restaurant industry finally has
something to cheer about after a dismal run last quarter. People
are now more than willing to leave the confines of their homes and
spend on dining out. Though the cautious spending mindset of
consumers persists overall, the restaurant industry can breathe a
sigh of relief in view of this encouraging trend. Leaving behind
the woes of last year and the inclement weather in Jan and Feb
2014, the U.S. restaurant industry began the second quarter of the
year on a rather positive note.
According to Black Box Intelligence and People Report, the
restaurant industry reported positive same-store sales in the
months of March and April, a relief from the negative comps seen
since Nov 2013. Comps increased 0.7% and 0.6% in March and April,
respectively, owing to improved weather.
Moreover, improving Restaurant Performance Index and the Current
Situation Index reflect accelerated economic expansion and
underlying strength in the industry. The strength in the U.S.
restaurant industry is backed by pent-up demand from consumers to
live and eat well.
Going forward, we expect the outlook for the restaurant industry to
get better driven by innate fundamental strengths, reflecting an
improving economic backdrop. Statistics bear out this relatively
favorable environment. Restaurant-and-foodservice sales are
anticipated to be $683.4 billion in 2014, up 3.6% year over year,
as per the National Restaurant Association. In real terms, this
will mark the fifth consecutive year of growth in restaurant sales.
However, the industry has its share of challenges, the most
concerning being the rise in food costs. Food costs were up 0.4% in
April, the fourth straight month of increase. Moreover, meat prices
increased 8.4% in April this year. These factors indicate that
inflation may be creeping up.
The overall economic environment is improving. However, the
year-over-year decline in guest count remains a concern. Though up
sequentially, same-store traffic for the month of April declined
1.1% year over year. As per media reports, the industry has yet to
achieve an improving same-store guest count since the end of the
Meanwhile, the industry is dependent on broad macroeconomic
factors, with dining out being a largely discretionary activity.
The economic climate largely influences restaurant choices for
customers. The Consumer Confidence Index declined sequentially in
Apr 2014 as consumers deemed current business and labor market
conditions less favorable. Further, we believe issues related to
"Obamacare," volatility in housing data and fuel prices and excess
supply may continue to cast shadows on the long-term picture.
Domestic and International Unit Expansion
After emerging from a lackluster economy that lasted for three
years, most of the companies had stepped up their pace of
restaurant openings. Not content with domestic expansion alone, the
companies were looking to test waters as well as developing taste
buds in foreign shores. Restaurateurs are primarily concentrating
on emerging markets that provide ample opportunities for
The burgeoning middle income population in emerging countries
encourages these companies to shift their spotlight from the
somewhat saturated domestic market.
Burger King Worldwide, Inc.
The Wendy's Company
Popeyes Louisiana Kitchen, Inc.
) have been quite active on this front.
Refranchising, Revamping & Innovating Menus - A Common
Though refranchising was common in the restaurant sector, it has
gotten a boost lately given the benefits of this business model
even in an anemic economy. The franchise-centric model helps to
reduce volatility in earnings and enhances cash flow generation.
Yum! Brands, Inc.
) are examples of highly franchised brands.
Additionally, restaurants are responding in different ways to
address heightened competition in a somewhat over-supplied domestic
market. Most industry players are remodeling their restaurants to
give an up-market feel as well as rolling out new and smaller
prototypes to augment the perception of value and drive traffic,
thereby reducing construction and occupancy costs and enhancing
returns on capital.
Jack in the Box Inc.
) and Wendy's Company have been working along these lines.
Apart from reimaging,
Brinker International, Inc.
Red Robin Gourmet Burgers Inc
Texas Roadhouse, Inc.
), are also working on smaller prototype restaurants that help to
accelerate growth in non-traditional locations, drive traffic,
thereby improving return on investment. Companies such as
Darden Restaurants, Inc.
BJ's Restaurants, Inc.
) are busy investing in kitchen equipments to improve capacity and
Having stabilized their financial positions, the operators are
constantly striving to add new offerings to their menu card in
order to cater to the ever-changing palates of customers while
making food presentation better.
Buffalo Wild Wings Inc.
), Brinker International and Texas Roadhouse are keenly focusing on
Restaurateurs like BJ's Restaurants, and
Panera Bread Company
) are offering loyalty programs at their units to enhance value
dining. This is a ploy to encourage sales at a time when customers
are spending less on dining and need added incentives. Most of the
operators rely on social media for promotions by incorporating
), online review sites,
) and blogs aggressively into their marketing mix. National
Television advertising is also an important tool for promotion.
Modern Technology, Digital Ordering, & Delivery Gaining
The digital wave has hit the U.S. fast casual restaurant sector as
more and more restaurants are deploying technology to enable a
better guest experience. The National Restaurant Association notes
that technology will make pervasive inroads into the restaurant
sector. Smartphone apps will lure consumers to the restaurants
while video menu boards in quick-service restaurants and the
growing application of tabletop devices in casual dining give
operators some of the latest tools to push sales. A few restaurants
chains that are aggressively moving on this track are Panera Bread,
Buffalo Wild Wings and
Krispy Kreme Doughnuts, Inc.
) that use Tablets and Kiosks to drive traffic.
Restaurateurs are also fast catching up on this growing trend of
digital ordering. So far,
Domino's Pizza, Inc.
) has been a huge beneficiary of this trend. A few others following
the footsteps of this leading pizza brand are
Papa John's International Inc.
Cracker Barrel Old Country Store, Inc.
Though delivery was common in the restaurant sector, especially
among pizza chains, increasingly busy lifestyles have given it a
boost. A couple of dining chains like Burger King and BJ's
Restaurants now cater to deliveries. Apart from this, catering
initiatives are also doing the trick for companies like Panera
Chipotle Mexican Grill, Inc.
Change in Consumer Preference:
The latest trend at U.S. eateries is to serve a healthy menu, owing
to consumer preference for fresh, organic, nutritious and low
calorie food. Rising health concerns and increasing awareness
about obesity and related diseases have led to the shift in
consumer preference toward healthy and "good for you" products.
Focus on child nutrition is also a priority. A few companies like
Burger King, Chipotle Mexican Grill,
The Hershey Company
) are coming up with low-calorie offerings to improve revenues and
Currently, Buffalo Wild Wings carries a Zacks Rank #1 (Strong Buy).
A few companies with a Zacks Rank #2 (short-term Buy rating)
Carrols Restaurant Group, Inc.
Fiesta Restaurant Group, Inc.
Ruth's Hospitality Group Inc.
) and Yum! Brands. Despite having a Zacks Rank #3 (Hold), we are
optimistic about Chipotle Mexican Grill, Wendy's Company and
Domino's Pizza owing to their strong results and future outlook.
Commodity Cost Inflation:
Food costs account for about one-third of restaurant sales, thus
making the industry excessively vulnerable to food cost inflation.
Increase in demand for a commodity is always good news for
producers. However, it is only when there is inadequate supply of a
particular commodity that prices start to rise. Currently, beef
prices are soaring and have hit their highest level in almost three
decades. (Read More:
Soaring Beef Prices:
3 Stocks to Feel the Bite
Moreover, the situation is not expected to improve in the
near-term. The U.S. Department of Agriculture forecasts that
food-at-home inflation as well as food-away-from-home inflation
index in the U.S. is expected to grow year over year in the range
of 2.5-3.5% in 2014. This would likely leave less room for consumer
companies to exercise pricing action, which would put pressure on
The brunt of government budget cuts, higher gasoline prices,
payroll tax increases and delayed tax refund checks leave less room
for consumer companies to pass on the rising food costs to
customers, thus pressurizing profits.
Global Economy Yet to Recover Fully:
According to the European Central Bank, though financial markets in
the region have improved, they are yet to reach pre-crisis levels.
The big chains have considerable exposure in European nations like
France and Germany and in Asian countries like China. Despite
improving economic data, German customers remain extremely
value-sensitive. Among the emerging nations, China and Brazil have
their own share of problems. Japan also continues to be a dampener
as it is still recovering from the 2012 earthquake.
Affordable Care Act to Hurt Margins:
Since the sector plays a key role in the nation's employment
picture, the recent Affordable Care Act by President Obama,
commonly known as Obamacare, is expected to have an adverse impact
on the operators' margins starting 2014. The law entails companies
to provide coverage for workers or face government penalties,
though it is not applicable for employees who log less than 40
hours per week on an average. To avoid these austerities, most
companies are trying out different labor models like involving more
part-timers and cutting work hours, which would hurt margins at the
There are some names that induce our cautious to bearish outlook.
Bob Evans Farms, Inc.
The Cheesecake Factory Inc.
Dunkin' Brands Group, Inc.
), all with a Zacks Rank #4 (Sell). Though
Bloomin' Brands, Inc.
) has a Zacks Rank #3, we have a bearish outlook over the company
as we expect it to be impacted by food cost inflation owing to its
focus on beef offerings. We also have a pessimistic view on Darden
Restaurants due to its soft third-quarter fiscal 2014 results and
Zacks Industry Rank - Neutral Outlook
Within the Zacks Industry classification, the restaurant industry
is grouped within the broader Retail sector. We rank all 260+
industries in the 16 Zacks sectors based on the earnings outlook
and fundamental strength of the constituent companies in each
industry. To learn more visit: About
Zacks Industry Rank
As a guideline, the outlook for industries in the top 1/3rd of all
Industry Ranks or a Zacks Industry Rank of #88 and lower is
'Positive,' the middle 1/3rd or industries with Zacks Industry Rank
between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks
Industry Rank of #177 and higher is 'Negative.'
The Zacks Industry Rank for the restaurant industry is currently at
#146. This is in the middle 1/3rd of all industries ranked,
highlighting the group's near-term Neutral outlook.
We believe that the Neutral outlook comes in the wake of major
near-term concerns such as significant food cost inflation (Read
Will Food Price Inflation Hurt Restaurateurs?
) and meager wages at fast food joints like McDonald's Corp. (
) and Yum! Brands which is leading to strikes by its employees.
Fast Food Workers on Strike Globally
). However, these negatives are being offset by the continuing
improvement in comps.
The restaurant industry falls under the broader Retail-Wholesale
sector, which has an earnings beat ratio of 38.5% and revenue beat
ratio of 42.3%.
Earnings growth of 0.9% was seen at the sector in the first
quarter, down from 1.0% growth in the fourth quarter of 2013 due to
higher food costs and other expenses. On the revenue front, the
sector recorded an increase of 3.6% in the first quarter, flat
Looking at the consensus expectations for second quarter of 2014,
earnings are expected to climb 5.1%. For 2014, earnings are
expected to increase around 9.3% with growth coming in the third
and fourth quarters of the year. Revenue is expected to grow 5.2%
in the second quarter of 2014. For 2014, revenues are expected to
increase 5.6%, primarily on the back of top line increases in the
third and fourth quarters.
For more details about earnings for this sector and others, please
read our '
Among the companies in our coverage, Wendy's Company posted solid
first quarter results with earnings and revenue beating the Zacks
Consensus Estimate on comps growth. However, The Cheesecake Factory
missed the Zacks Consensus on earnings due to inclement weather
while revenues beat.
A look at the
in the table below shows that Darden Restaurant, Brinker
International and BJ's Restaurants could miss the Zacks Consensus
Estimate in their upcoming quarterly results (first quarter 2014).
In hindsight, the performance of the restaurant sector was more or
less satisfactory in the March quarter compared to the second half
of 2013. For 2014, the industry is expected to generate growth as
it focuses on inspired ways of meeting consumer demand. However,
the sector will continue to face headwinds from a weak consumer
spending environment and higher food costs.
It's high time that these food chains focus on strategies that will
help them alleviate the impact of increased costs. Implementing the
right pricing strategy, increasing global presence and focusing on
supply chain revenues are key for restaurateurs. Overall, the
restaurant industry is expected to sustain its general pace of
recovery in 2014, albeit a bit slower as it contends with several
global economic concerns.
Our proprietary Zacks Rank indicates the movement of the stocks
over the short term (1 to 3 months). At present, 30.8% and 53.8%
stocks hold a positive and neutral outlook, respectively, while the
remaining 15.4% hold a negative outlook.
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