The U.S. restaurant industry has ended the first half of 2012 on
a positive note despite nagging sovereign debt issues in Europe and
faltering domestic consumer confidence. The strength was backed by
modest traffic improvement and the consequent rise in comparable
store sales. Easy comparisons from 2011 will likely place
forthcoming performance of 2012 in a brighter light.
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 101.6 in
April, slightly down from the extremely strong level of 102.2 in
March. Despite the decline, January characterized the sixth
consecutive month in which RPI stood above 100. This RPI run-rate
in the last six months connotes improvement in comparable store
sales and customer traffic.
Most of the restaurant operators reported positive same-store
sales and a majority of them expect business to gain momentum in
the months ahead.
The Current Situation Index, which measures comparable store
sales, traffic count, labor costs and capital expenditures in the
restaurant industry, was 101.0 in April, down 1.0% sequentially.
The Expectations Index, which measures restaurant operators'
six-month outlook on the above indicators, was 102.2, slightly down
from 102.4 in March. This was the eighth 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.
All these culminate to the general optimism in the sector. We
are hopeful that restaurant companies will continue to deliver
better numbers in the upcoming quarter despite macroeconomic
weaknesses. An improving outlook can be validated by the NPD
foodservice market research report, which stated that annual visits
to restaurants will increase by 8% in the next decade.
Road Ahead
We see modest top- and bottom-line trends in 2012. According to
a research conducted by 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
research firm estimates total restaurant industry sales to increase
3.5% year over year to $632 billion in 2012, thus marking the
second consecutive year of total industry sales of more than $600
billion.
Most of the restaurant operators are passing on higher costs to
consumers in order to mitigate commodity pressures. The companies
that are well positioned are likely to enjoy pricing power and in
turn same-store sales increase. The improvement in the U.S. economy
is slow but palpable. But a sluggish labor market, over-supply of
restaurants in the industry, a still-hot food cost environment, a
still elevated unemployment level, credit unavailability, and weak
income growth may weigh on industry profitability.
Restaurants have been trying to win back cash-conscious guests
by revamping promotions 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.
OPPORTUNITIES
Improved Californian Market
The core California market, which was badly hit by the recession
resulting in a high rate of unemployment and weak consumer
confidence, has turned around. We see plenty of growth
opportunities in the California and Texas markets.
BJ's Restaurants
(
BJRI
) and
Red Robin Gourmet Burgers Inc.
(
RRGB
) are expanding rapidly in California.
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.
workforce. This projected employment figure represents
year-over-year growth of 2.3% while total U.S. employment is
believed to grow 1.3%. Among all markets, Texas and Florida are
envisioned to see maximum job growth, among all other markets in
the restaurant industry over the next 10 years.
Domestic and International Unit Expansion
Emerging from a lackluster economy from more than two years
back, most of the companies have accelerated their pace of
restaurant openings. A relative recovery in consumer confidence has
also encouraged companies to return to unit expansion.
In fact, the companies are also exploring international markets.
Restaurateurs are primarily concentrating on emerging markets that
provide ample opportunities for expansion. 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. They are
aggressively expanding in China to capitalize on the fast-paced
economic growth over there. Some European countries including U.K.,
Germany and France are also not far behind.
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
upmarket 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.
McDonald's is continuously benefiting from its reimaging. This
year, the company expects to see a comps gain of 5-6% from its
"facelifts."
This is not the end. Having stabilized their financial
positions, the operators are well poised to bring newer offerings
to their menu card in 2012 in order to cater to the ever-changing
demands of customers. Limited Time Offers are also gaining
attention.
Marketing Tools
Social media as a marketing tool has taken the industry by
storm. Most of the operators rely on social media for promotion.
Hence, we believe they are likely to incorporate Facebook, online
review sites, Twitter and blogs aggressively into their marketing
mix going forward. National Television advertising is also an
important tool for promotion. A company like
Panera Bread Co.
(
PNRA
), successful even during the recession, increased its advertising
spending by 26% for 2012 over an above 32% increment in 2011.
Loyalty Program
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 the trend. For example,
Panera Bread rolled out "My Panera" loyalty program in November
2010. Since its inception, the program has developed a database of
over 10.4 million registered users in March 2012 (up from 9.5
million in the prior quarter).
Pricing Power
We have seen most of the companies take pricing action in last
few months. The faster-rising inflation of food at home compared to
food away from home might allow the U.S. eateries some room to take
additional pricing actions in the near term.
Growing Fast-Casual Segment
According to a recent NPD foodservice market research report,
fast casual is the only restaurant segment growing at a steady pace
in the last five years. The segment quintessentially offers
healthier options with respect to menu with a premium setting and
rational pricing. The highlight of this segment is the counter
service, which considerably saves on labor costs. Panera Bread,
Noodles & Company, Five Guys and Pei Wei are some restaurateurs
enjoying their positioning in this category. The segment comprises
a small part of the industry sales, leaving further scope for
growth.
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. Franchising is also an important
factor for international development. However, Panera Bread is more
inclined toward company-owned unit openings, which speak well of
its fundamental strength and make us optimistic on the stock.
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,
Jamba Inc.
(
JMBA
),
The Wendy's Company
(
WEN
) and
Yum! Brands
(
YUM
) all have expedited their breakfast menu. McDonald's is yet
another beneficiary of the increasingly popular breakfast menu.
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.
Non-alcoholic beverages remain a sweet spot in the U.S.
eateries. According to Mintel Global Market Navigator, the U.S.
fruit juice drinks market expanded by 1% in 2011. This was a steady
gain on the 1.7% fall recorded in 2009 and breakeven in 2010. 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. McDonald's has been delivering strong
comparable sales in the U.S., buoyed by its McCafe line.
We see continued sales recovery in the next few months as cold
beverages provide a higher run in comps against hot beverages in
winter.
M&A Activity
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 restaurant industry and accordingly
plunging into the buyout deals. Some recent deals include the
proposed sale of Benihana by a private equity group Angelo, Gordon
& Co.,
P.F. Chang's China Bistro's
(
PFCB
) takeover by Centerbridge Partners, Fidelity National
Financial's acquisition of O'Charley's.
Apart from acquisitions, the companies are also divesting their
slow-moving brands in order to spur growth. For example, Yum!
Brands disposed two of its brands Long John Silver's and A&W,
Wendy's broke up with Arby's and
Frisch's Restaurants Inc.
(
FRS
) divested all its Golden Corral operations.
Currently, there are a number of stocks in the restaurant with a
Zacks #1 Rank (short-term Strong Buy rating). These include
Brinker International Inc.
(
EAT
),
Einstein Noah Restaurant Group Inc.
(
BAGL
) and Jamba. Companies with Zacks #2 Ranks (short-term Buy rating)
include
Benihana Inc.
(
BNHN
),
Cosi Inc.
(
COSI
),
Texas Roadhouse Inc.
(
TXRH
),
Kona Grill Inc.
(
KONA
).
WEAKNESSES
Higher Cost Structure
We remain wary of the rising commodity costs of the restaurant
industry. Food costs account for about one-third of restaurant
sales. Wholesale food prices increased in 2011. Beef prices
continue to rise in 2012 on a year-over-year basis. Companies
like Red Robin Burger, McDonald's and Texas Roadhouse, 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 in 2012.
Seafood prices are also creeping up, putting companies like
Darden's margin at stake. However, some
softening is being noticed in dairy as well as produce prices. A
few companies are expecting food cost inflation to moderate,
especially in the latter half of 2012.
According to the Green Restaurant Association, restaurants
account for one-third of all the U.S. energy used by the retail
sector. Hence, rise in energy costs remain another risk to the
restaurateurs.
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.
Steep Competition and Promotional Offers
The restaurant industry 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.
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 inflow, changes in internal fiscal and monetary
policies led to the decline in the estimated growth rate in China
and India.
According to the IMF, the Chinese economy is projected to grow
8.2% and 8.8% in 2012 and 2013, respectively, while India is
expected to post 6.9% growth in 2012 and 7.3% in 2013. Japan also
continues to be a dampener as it is still on the way to recovery
from the last year's earthquake. The trend can be validated from
the May comparable sales trend in McDonald's where comps dropped
1.7% in Asia Pacific Middle East and Africa versus a growth of 4.3%
in the year-ago month.
Eurozone Debacle
To add to this, there is the overcast European financial
atmosphere which has slowed down the overall growth rate in the
region since the second half of 2011. Some food companies, which
have so far endured the recent economic turmoil in Europe, began to
believe that the implementation of austerity measures will now put
pressure on its top and bottom lines. With the focus on value
proposition along with less pricing power, margins will likely be
hassled there, at least in the near term until any concrete
solution crops up.
Stringent Food Standards
Consumer's 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. While these criteria are giving a
competitive advantage to companies like Chipotle, many others are
sometimes finding the standard tough.
Restaurant and beverage companies' momentum will likely be
hitched in New York area in the near term as Mayor Bloomberg is
trying to forbid the sale of large sodas and sugar drinks.
This ban, if implemented, could prove pricey for the fast-food
industry as soft drinks carry a high margin.
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
Domino's Pizza Inc.
(
DPZ
),
DRI Restaurants Inc.
(
DRI
),
The Cheesecake Factory
(
CAKE
) Panera Bread and Yum! Brands, all of which retain the Zacks #3
Rank (short-term Hold). McDonald's, Carrols Restaurant and
Krispy Kreme Doughnuts, Inc.
(
KKD
) still carry a Zacks #4 Rank (short-term Sell).
Conclusion
The restaurant industry is still not immune to uncertainties in
the macro-economy. Industry behemoths like McDonald's are caught up
with difficulties like implementation of austerity measures in
Europe, increasing commodity costs in the U.S. and sluggish growth
in Asia. On the domestic front, although the economy has been
improving, full-fledged consumer response has yet to be seen. They
are slowly regaining confidence and cautiously dining out. We
believe the companies with strong cash flow generation will survive
the market volatility.
EINSTEIN NOAH (BAGL): Free Stock Analysis
Report
CHIPOTLE MEXICN (CMG): Free Stock Analysis
Report
DENNY'S CORP (DENN): Free Stock Analysis Report
DOMINOS PIZZA (DPZ): Free Stock Analysis Report
DARDEN RESTRNT (DRI): Free Stock Analysis
Report
BRINKER INTL (EAT): Free Stock Analysis Report
MCDONALDS CORP (MCD): Free Stock Analysis
Report
PANERA BREAD CO (PNRA): Free Stock Analysis
Report
RUBY TUESDAY (RT): Free Stock Analysis Report
STARBUCKS CORP (SBUX): Free Stock Analysis
Report
CARROLS RESTRNT (TAST): Free Stock Analysis
Report
WENDYS CO/THE (WEN): Free Stock Analysis Report
YUM! BRANDS INC (YUM): Free Stock Analysis
Report
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