The outlook for the restaurant industry is steadily improving
despite the macroeconomic overhang, with the easing in food cost
inflation and increase in same-store sales giving the group's
near-term earnings prospects a boost. The outlook for the rest of
the year is optimistic given easy year-over-year comparisons.
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 101.0 in April, up
0.4% sequentially. The RPI level was the highest in the last 10
months. The figure also exceeded the 100 mark for the third time in
the last four months.
Current Situation Index, which measures comparable store sales,
traffic count, labor costs and capital expenditures in the
restaurant industry, was 100.1 in April, up 0.3% sequentially. The
Current Situation Index stood above the 100 level for the first
time in eight months, signifying the underlying strength in the
The Expectations Index, which measures the restaurant operators'
six-month outlook on the above indicators, was 101.9 in April, up
0.5% sequentially. The level was also the highest in 11 months. All
three indices managed to beat the safety threshold of 100,
reaffirming operators' positive outlook on the industry for the
Yearly hikes in dividends on a regular basis by some industry
Yum! Brands Inc.
Brinker International Inc.
) underscore their efforts to consistently return shareholder and
franchisee value irrespective of the economic peaks and valleys.
Cracker Barrel Old Country Store Inc.
), has doubled its dividend since Apr 2012.
Moreover, the Conference Board came out with its Consumer
Confidence Index -- a barometer of U.S. consumer health -- on May
28, 2013. The index improved consecutively in April and May. The
Index stood at 76.2, up from 69.0 in April, and this also marks the
five-year high level.
The sentiment was also upbeat for the labor and housing market.
Fuel prices are hovering below year-ago levels. All these
culminate to the general optimism in the sector. That said, we
believe, issues like new stipulations related to "Obamacare," and
excess supply may cloud the long-term picture. An extensive focus
on value proposition along with moderate pricing power could also
prove unfavorable to margins if exercised on a long-term basis.
Zacks Industry Rank
Within the Zacks Industry classification, the restaurant industry
is grouped within the broader Retail sector. We rank all the 260
plus 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
#43, down 6 spots in the last week. This is in the top 1/3rd of all
industries ranked, highlighting the group's near-term Positive
outlook. The group's favorable Zacks Rank placement is essentially
a function of many restaurant companies' improved earnings picture
that prompted analysts to raise their estimates.
Key Performers in First-Quarter 2013
Not all companies performed equally well in the quarter. While some
were laggards, others posted solid results mostly on their
individual strength. Thanks to favorable weather last year, many
restaurateurs faced tough comparisons in the first quarter and
failed to exceed the year-ago quarter's solid comparable sales
numbers. Most of the chains posted weaker-than-expected revenue
numbers, but, on a bullish note, managed to score on earnings owing
to cost savings and policies such as share repurchase. Operators
blamed a softer economic trend for the insignificant growth in
Industry behemoth McDonald's delivered weaker-than-expected results
in the first quarter on both counts, while another renowned
operator, Yum! Brands, registered weak sales owing to the recent
ordeals in its China business. However, we believe both companies
will rebound over the longer term, once global issues subside.
Some other notable companies like Brinker beat earnings but missed
) earnings were in-line but revenues outperformed.
Krispy Kreme Doughnuts Inc.
Domino's Pizza Inc.
) beat both revenues and earnings. Same-store sales growth at
Krispy Kreme, Domino's, Jamba, AFC Enterprises and Panera deserves
According to the National Restaurant Association, the restaurant
industry is projected to expand in 2013 on the back of U.S.
recovery, albeit at a slow pace. Like 2012, focus on cost
containment, extra value-for-price and international expansion will
be on most restaurateurs' wish-list to tide over the some macro
difficulties this year.
According to the National Restaurant Association, as much as 41% of
restaurant operators expect to see an uptick in sales in the coming
six months on an improving economy. Restaurant operators' capital
spending plans are also riding uphill, reaffirming their positive
outlook. We are optimistic of bottom-line expansion in the near
The National Restaurant Association estimates a 3.8% year over year
increase in total restaurant sales to $660.5 billion in 2013.
However, inflation-adjusted sales suggest only 0.8% growth. If
realized, this would mark the third straight year of above $600
billion total industry sales. The limited-service eating-place
segment will likely grow faster than the full-service restaurant
Favorable Outlook for the Upcoming Quarter
A faster pace of recovery in the U.S., easy year-over-year
comparison and events such as Mothers' Day will likely boost the
second-quarter same-store sales of most of the companies.
Darden's successful value proposition and its gradual positioning
in the upscale segment, solid first-quarter earnings and revenue
growth along with raised full-year guidance at Cracker Barrel, Papa
John's International and Krispy Kreme, reinvigoration of Yum!'s
Taco Bell and Domino's Pizza's entry into the pan pizza category
are likely to prove beneficial.
However, the shift in Easter from second quarter last year to first
quarter this year will likely be a drag on the sales. Further,
companies like Yum! and McDonald's, which have considerable
exposure in the Chinese market, could face a setback owing to the
recent outbreak of the Avian Flu scare.
Cooling Commodity Inflation in the US
The food cost inflation seems to have lessened despite the severe
drought in the Midwest growing region last year. Food costs account
for about one-third of restaurant sales, thus making the industry
vulnerable to food cost inflation.
As suggested by the U.S. Department of Agriculture (USDA) report,
price inflation for all food is expected at 2.5-3.5% in 2013 down
from the prior expectation of 3-4% level. Commodities like fish and
seafood, dairy products, fats and oils, cereals and bakery products
and other foods will likely witnessed a decline in prices.
However, prices for beef, pork and poultry are expected to remain
firm in 2013, with beef prices being the highest. The drought in
the Midwest growing region last year resulted in steeper grain
costs, which in turn pushed up the feed costs. Companies like Red
Robin Burger (
), McDonald's and Texas Roadhouse have the higher exposure to the
beef market and will likely feel the brunt of beef inflation.
But there is some good news. The market is abuzz with assumptions
that feed prices will cool off with the new harvest season and that
could lead to lower chicken prices in 2014.
Continued Job Growth in the Sector
The restaurant industry has been one of the major contributors to
job growth in the U.S. over the last couple of years. The sector
employs around 10% of the U.S. workforce. According to the National
Restaurant Association, in 2011 and 2012, total U.S. employment
grew a respective of 1.0% and 1.4% while restaurant employment
increased 1.9% and 3.0%.
The National Restaurant Association expects this industry to create
2.4% additional jobs compared to a projected 1.5% gain for total
Domestic and International Unit Expansion
Emerging from a lackluster economy from more than three 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.
Besides spreading out in their 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
) and Krispy Kreme are tapping the fast-growing Indian market.
McDonald's Corp. and Yum! already have considerable coverage in
India and are now aggressively expanding in China to capitalize on
the fast-paced economic growth there. Latin America has also become
a preferable venue for expansion.
Refranchising, Revamp & Menu Innovations - a Common
Though refranchising was common in the restaurant sector, it has
gotten a boost of late 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.
Burger King Worldwide Inc.
) are some examples of highly franchised brands.
Additionally, restaurants are responding in a variety of 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. Operators like McDonald's,
The Wendy's Company
Darden Restaurants Inc.
) and Jamba are working along these lines.
This is not the end. Having stabilized their financial positions,
the operators are constantly striving to add offerings to their
menu card in order to cater to the ever-changing palates of
customers. Limited Time Offers, loyalty programs and social media
are also drawing attention as marketing tools.
Restaurateurs are offering loyalty programs at their units to
enhance value dining as well as hone sales when customers are
spending less enthusiastically on dining yet seeking incentives for
doing so. Most of the operators rely on social media for promotions
), online review sites, Twitter and blogs aggressively into their
marketing mix. National Television advertising is also an important
tool for promotion.
Focus on Hispanic Guests
In a bid to tap the rapidly growing Hispanic customer base in the
U.S., many restaurant units are launching a new language setting in
their ordering app for smartphones. The restaurants are also
introducing a national online marketing campaign targeting Hispanic
guests. These brands are
Dunkin' Brands Group
), Domino's Pizza, The Wendy's and Denny's.
As per data published by market researcher NPD Group in Feb. 2012,
the Hispanic community accounts for about 16% of the U.S.
population based on the 2010 U.S. Census. The U.S. Census projects
the Hispanic population in the country to increase 34% from 2010 to
2020. This encouraging data might have shifted several
restaurateurs' attention towards this community.
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, McDonald's,
), DineEquity and Yum! have all broadened their breakfast menus.
Non-alcoholic beverages remain another 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. Apart from Juicing, both Jamba and Starbucks are brewing
more opportunities in the tea category.
M&A Activity Gaining Precedence
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. One of the latest acquisition deals worth
mentioning is the buyout of Caribou Coffee Company by JAB Group.
Apart from acquisitions, the companies are also divesting their
relatively slow-moving brands in order to spur growth. One of the
latest divesture deals that warrants a look is the sell-off of
Mimi's Café concept of
Bob Evans Farms Inc.
) to LeDuff America.
CEC Entertainment Inc.
Bloomin' Brands Inc.
) carry a Zacks Rank #1 (Strong Buy). Companies with a Zacks #2
Rank (short-term Buy rating) include Krispy Kreme, AFC enterprises,
Burger King, Cheesecake Factory,
), Cracker Barrel, Texas Roadhouse, Wendy's, and
). These companies have positive earnings estimate revision trends,
highlighting the favorable momentum in their underlying businesses.
Bleak Global 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 and decelerating growth in Asia.
The recent same-store sales performance of McDonald's is indicative
of a slowdown in the Asian countries like China and India as well
as European nations like France and Germany. Japan also continues
to be a dampener as it is still on the way to recovery from last
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 in 2014.
The law entails companies to provide coverage for workers or face
government penalties, though not applicable for employees who log
less than 30 hours per week on average.
To avoid these austerities, most companies are trying out different
labor models like involving more part-timers and cutting work hours
in advance of the implementation of the healthcare reform. Darden
Restaurants is one of these.
Rising energy cost is another risk faced by restaurateurs. The
industry accounts for one-third of the energy used by the retail
sector in the U.S., as per the Green Restaurant Association.
Stringent Food Standards
Consumers' inclination toward fresh organic menu and the fuss about
nutrition pose challenges. Consumers generally tend to visit
restaurants offering locally produced food. Focus on child
nutrition is also a priority. While these criteria are giving a
competitive advantage to companies like Chipotle Mexican Grill,
others often find it difficult to meet these standards.
There are some names that induce our cautious outlook. These
include Red Robin Gourmet Burgers, Yum!,
Kona Grill Inc.
Buffalo Wild Wings Inc.
Panera Bread Co.
Chipotle Mexican Grill Inc.
), BJ's restaurants all of which retain the Zacks #3 Rank (Hold).
McDonald's still carries a Zacks Rank #4 (Sell) due to persistent
deceleration in comparable store sales.
AFC ENTERPRISES (AFCE): Free Stock Analysis
BJ'S RESTAURANT (BJRI): Free Stock Analysis
BUFFALO WLD WNG (BWLD): Free Stock Analysis
CHEESECAKE FACT (CAKE): Free Stock Analysis
CRACKER BARREL (CBRL): Free Stock Analysis
CHIPOTLE MEXICN (CMG): Free Stock Analysis
COSI INC (COSI): Free Stock Analysis Report
DINEEQUITY INC (DIN): Free Stock Analysis
DUNKIN BRANDS (DNKN): Free Stock Analysis
DOMINOS PIZZA (DPZ): Free Stock Analysis Report
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
MCDONALDS CORP (MCD): Free Stock Analysis
PANERA BREAD CO (PNRA): Free Stock Analysis
RED ROBIN GOURM (RRGB): Free Stock Analysis
YUM! BRANDS INC (YUM): Free Stock Analysis
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