Despite beginning the year on a relatively positive note, sales
momentum in the U.S. restaurant industry appears to have slackened
in the second quarter of 2012, mostly reflecting macroeconomic
issues. The industry has been at the receiving end of the global
economic concerns, a stronger dollar, the uncertainty around
upcoming presidential election in the U.S., a more expensive food
cost environment in the U.S., a sluggish labor market and
over-supply of restaurants in the industry.
Despite these hurdles, the restaurant sector is expected to sustain
its pace of recovery this year, albeit at a slower clip.
We remain cautiously optimistic over the medium term, though
same-store sales growth in the coming months will likely be
subdued. According to the National Restaurant Association, the
restaurant industry is projected to expand in 2012 despite the
sluggish U.S. recovery. Focus on cost containment, extra
value-for-price and international expansion are on most
restaurateurs' wish-list to tide over the macro difficulties.
The industry association noticing "substantial pent-up demand" in
the market estimates total restaurant sales to increase 3.5% year
over year to $632 billion in 2012. If realized, this would mark the
second straight year of total industry sales exceeding the $600
Yearly hikes in dividend on a regular basis for some industry
Yum! Brands Inc.
Brinker International Inc.
) underscores their concerted efforts to consistently return
shareholder and franchisee value irrespective of the economic peaks
and valleys. Yet another improving outlook was dished out by the
NPD foodservice market research report, which stated that annual
visits to restaurants will increase by 8% in the next decade.
Statistics bear out this relatively favorable environment. A recent
survey by the National Restaurant Association revealed that the
Restaurant Performance Index (RPI), measuring the present condition
and outlook on the U.S. restaurant industry, was 100.6 in August,
up 0.4% sequentially, the tenth consecutive month in which the RPI
scored above 100. This RPI run-rate in the last ten months connotes
improvement in comparable store sales and customer traffic.
The Current Situation Index, which measures comparable store sales,
traffic count, labor costs and capital expenditures in the
restaurant industry, was 100.6 in August, up 0.8% sequentially. The
Expectations Index, which measures the restaurant operators'
six-month outlook on the above indicators, was 100.7, at par with
the July level.
This was the twelfth consecutive month that the Expectations Index
remained above 100. Restaurant operators' capital spending plans
are also riding uphill, reaffirming their positive outlook on the
industry longer term.
Job Growth in the Sector
The restaurant industry is one of the major contributors to job
growth in the U.S. In 2011, total U.S. employment grew 1.0% while
restaurant employment increased 1.9%. According to the National
Restaurant Association, overall restaurant industry employment will
reach 12.9 million in 2012, accounting for 10% of the total U.S.
This projected employment figure represents year-over-year growth
of 2.3%, while total U.S. employment is believed to grow 1.3%.
Texas and Florida are envisioned to see maximum job growth, among
all other markets in the restaurant industry, over the next 10
Global Unit Expansion
Putting behind the economic downturn that paralyzed the U.S.
economy a couple of years back, most companies in the sector are
accelerating their pace of restaurant openings. A relative recovery
in consumer spending has also encouraged companies to return to
Besides spreading their wings in the home country, the companies
also aim to test waters in foreign shores. Restaurateurs are
primarily concentrating on emerging markets that provide ample
opportunities for expansion. The burgeoning middle income
population in emerging countries encourages the companies to shift
their spotlight from the somewhat saturated domestic market.
Several food chains, including
Pollo Tropical of Carrols Restaurant
) are eyeing to tap the fast-growing Indian market. McDonald's
Corp. and Yum! already have considerable coverage in India . They
are aggressively expanding in China to capitalize on the fast-paced
economic growth there. Latin American countries are also not far
Refranchising, Revamp & Menu Innovations - a Common
Though refranchising was common in the restaurant sector, it has
got a boost of late given the benefits of this business model amid
an anemic economy. The franchise-centric model helps to reduce
volatility in earnings and enhances cash flow generation. Companies
Burger King Worldwide Inc.
) are some examples of highly franchised brands, with DineEquity
offloading 99% of its Applebees stake.
Additionally, restaurants are responding in a variety of ways to
address the issue of heightened competition in a somewhat
over-supplied domestic market. They are remodeling their
restaurants to give an up-market feel, 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. Operators like McDonald's,
The Wendy's Company
Darden Restaurants Inc.
) are continuously benefiting from unit-refurbishment strategy.
This is not the end. Having stabilized their financial positions,
the operators are constantly striving to bring newer offerings to
their menu card in order to cater to the ever-changing palates of
customers. As per the research conducted by Technomic, within the
fast casual segments, Mexican menus are presently ruling the
consumers' taste buds with a solid 20% share. Limited Time Offers
are also gaining attention.
Marketing Tools & Loyalty Program Gaining
Social media as a marketing tool has taken the industry by storm.
Most of the operators rely on social media for promotions by
), online review sites, Twitter and blogs aggressively into their
marketing mix. National Television advertising is also an important
tool for promotion.
As per research conducted by National Restaurant Association,
restaurateurs are offering loyalty programs at their units to
enhance value dining. Amid the prevailing environment where
customers spend less enthusiastically on dining and seek incentives
for doing so, approximately 30% of restaurant operators are
frequently coming up with diner programs to hone sales further. The
operators have now started to leverage this trend.
) has proved to be a beneficiary from both these tactics.
Breakfast & Beverage: A Breakout
Breakfast has accounted for nearly 60% of the U.S. restaurant
industry and remains a key driver of traffic growth in recent
years. Leveraging the trend,
), Wendy's and Yum! all have expedited their breakfast menus.
According to an analysis by NPD, which has a ten-year projection of
foodservice trends, annual servings per capita of breakfast
sandwiches at foodservice are expected to jump from 11 in 2004 to
14 in 2019.
Non-alcoholic beverages remain a sweet spot in the U.S. eateries.
The market also has the ability to grow further through innovation,
especially in healthier solutions. We see juicing giant Jamba
geared up to leverage the trend by adding all-fruits to its
line-up. There are other players like sector behemoths Starbucks
venturing into the $50 billion category of healthy juices and
McDonald's specializing in both frozen as well as hot beverages
through its McCafe line.
Merger and acquisition activity is also gaining momentum in the
sector. The companies are looking at potential business partners to
foray into different zones and unlock value. Private equity firms
are citing potential in the restaurant industry and accordingly
making buyout deals. Apart from acquisitions, the companies are
also divesting their slow-moving brands in order to spur growth.
Krispy Kreme Doughnut Inc.
) is the only stock in the restaurant sector that carries a Zacks
#1 Rank (short-term Strong Buy rating).
Companies with a Zacks #2 Rank (short-term Buy rating) include
Brinker International Inc.
Kona Grill Inc.
) and Panera Bread Co. Companies with Zacks #1 Rank and Zacks #2
Rank have positive earnings estimate revision trends, highlighting
the favorable momentum in their underlying businesses.
Bleak Economic Backdrop
The strengths aside, the companies are caught up with macroeconomic
tensions like implementation of austerity measures in Europe owing
to the sovereign debt crisis, decelerating growth in Asia and
increasing commodity costs in the U.S. Further, a stronger dollar
will likely threaten the companies with substantial operations
The overcast European financial atmosphere has slowed down the
overall growth rate in the region since the second half of 2011.
Some food companies that have hitherto endured the economic turmoil
fairly well are finally straining under the implementation of
austerity measures in Europe. The pressure is now beginning to be
felt on their top and bottom lines.
Decelerating Growth in Asia:
Growth has been moderating in Asia, especially in two major
countries -- China and India -- where major eateries are exploring
expansion opportunities in response to the saturation in the U.S
market. Steep decline in export to developed economies, lack of
foreign capital inflows, and changes in internal fiscal and
monetary policies led to the decline in the estimated growth rate
in China and India. The recent same-store sales performance of
McDonald's is indicative of this slowdown.
The growth prospects for China remain dull, as in the second
quarter of 2012, the country recorded growth of 7.6% -- its slowest
three-month annual growth in three years. As per IMF's July
forecast, China is expected to grow by 8.0% in 2012, down from its
April forecast of 8.2%.
The IMF has warned that the worsening debt crisis in the Eurozone
will pose a "key risk" to China's growth. For 2013, growth in China
is now expected to be 8.5% as compared to the earlier projection of
8.8%. Japan also continues to be a dampener as it is still on the
way to recovery from last year's earthquake.
The agency estimates weakening growth for India in 2012 and 2013.
In its July projection, the agency cut down its growth forecast for
India from 6.8% and 7.2% to 6.1% and 6.5%, respectively. For
Brazil, the agency reduced its growth forecast from 3.1% to 2.5%
According to a German newspaper, IMF will go for a further
reduction in its 2013 growth estimates. China and India are
expected to record 8.2% and 6.0% growth in 2013, respectively.
Growth estimate for Brazil is also expected to be slashed to 4.0%
from the earlier projection of 4.7%, according to the said source.
Commodity inflation in US: We remain wary of the rising commodity
costs of the restaurant industry. Food costs account for about
one-third of restaurant sales. Beef prices continue to rise in 2012
on a year-over-year basis. Companies like
Red Robin Burger
), which are exposed to the beef market, often feel the brunt of
price inflation. A continued rise in traditional wing prices, which
had been favorable earlier, is another weak pocket for the rest of
the year. We believe the threat for more inflation lurks in 2013.
Meanwhile, the drought in the Midwest growing region has caused a
spike in grain costs, which is likely to push up chicken costs
ahead. Further, the drought led to a sooner-than-expected supply of
cattle in the market leading to augmented near-term supply.
However, this might create a medium-term supply crunch. Some
softening is nonetheless being noticed in dairy and sea food
Rising energy cost is another risk faced by restaurateurs. The
restaurant industry accounts for one-third of the energy used by
the retail sector in the U.S., as per the Green Restaurant
Most of the restaurants safeguard their margins by passing the cost
hike onto consumers. While big and established chains like
McDonalds, Yum! Brands and Starbucks will survive the price
increases due to their broad customer base and larger economies of
scale, smaller chains will feel the cost pressure.
Decreasing Pricing Power
Menu pricing has been restaurateurs' remedy to counter cost
pressures. While some eateries had believed that food-at-home
inflation was rising faster than food-away-from-home, allowing them
room for additional pricing, their conviction has taken a beating
of late. According to the U.S. Department of Labor, food-at-home
inflation was up 1.5% in August while food-away-from-home inflation
was up 2.8% in the month under review. This inflationary
environment leaves lesser room to exercise pricing action in the
latter half of 2012.
Shrinking Margins on Value-Orientation
Restaurants have been trying to win back cash-conscious guests by
revamping promotions and focusing on value-for-meal menus. An
extensive focus on value proposition in the major markets
domestically and internationally along with less pricing power
could prove detrimental to margins if exercised on a long-term
basis. Although management at McDonald's noted that most of its
value-oriented sales measures are short-term in nature, we expect
the trend to be predominant, at least for the near future until any
concrete solution crops up.
Stringent Food Standards
Consumers' inclination toward fresh organic menu as well as the
fuss about nutrition is considered to be a tough benchmark in the
restaurant industry. Consumers generally tend to visit restaurants
offering locally produced food. Focus on children's nutrition has
also become a priority. While these criteria are giving a
competitive advantage to companies like
), many others are sometimes finding the standard difficult.
In the near term, restaurant and beverage companies, in the New
York area, will find the going difficult with Mayor Bloomberg
trying to forbid the sale of large sodas and sugar drinks. This
ban, which is likely to be implemented in March 2013, could prove
pricey for the fast-food industry as soft drinks carry a high
Given the lack of overall earnings catalysts, it's hard to be
upbeat about a number of restaurant stocks. There are quite a few
names on which we have a cautious outlook. These include Texas
DRI Restaurants Inc.
Domino's Pizza Inc.
), all of which retain the Zacks #3 Rank (short-term Hold).
The Cheesecake Factory
) still carry a Zacks #4 Rank (short-term Sell).
The restaurant industry is still not immune to uncertainties in the
macro-economy. On the domestic front, although the economy has been
improving, full-fledged consumer response has yet to be seen. Given
the soft international backdrop we expect this doldrums to persist
in the near term. Only the cash-rich companies will likely
survive this volatility smoothly.
BURGER KING WWD (BKW): Free Stock Analysis
CHEESECAKE FACT (CAKE): Free Stock Analysis
COSI INC (COSI): Free Stock Analysis Report
DINEEQUITY INC (DIN): Free Stock Analysis
DARDEN RESTRNT (DRI): Free Stock Analysis
BRINKER INTL (EAT): Free Stock Analysis Report
JAMBA INC (JMBA): Free Stock Analysis Report
KRISPY KREME (KKD): Free Stock Analysis Report
KONA GRILL INC (KONA): Free Stock Analysis
MCDONALDS CORP (MCD): Free Stock Analysis
PANERA BREAD CO (PNRA): Free Stock Analysis
TEXAS ROADHOUSE (TXRH): Free Stock Analysis
WENDYS CO/THE (WEN): Free Stock Analysis Report
YUM! BRANDS INC (YUM): Free Stock Analysis
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