For Immediate Release
Chicago, IL - April 28, 2017 - Today, Zacks Equity Research discusses the Industry: Restaurants, Part 1, including McDonald's Corp. (NYSE: MCD - Free Report ), Domino's Pizza, Inc. (NYSE: DPZ - Free Report ), The Wendy's Company (NASDAQ: WEN - Free Report ), Darden Restaurants, Inc . (NYSE: DRI - Free Report ) and Restaurant Brands International, Inc. (NYSE: QSR - Free Report ).
Industry: Restaurants, Part 1
The U.S. restaurant space had a dismal run over the past few quarters in spite of economic growth, lower energy prices and higher income. Consumers increased their spending only modestly on dining out, with the situation taking a turn for the worse, thanks to higher health care costs and tightened credit availability. As a result, traffic has been weak and same-store sales growth has been dull.
In fact, the first quarter of 2017 marked the fifth consecutive quarter of negative comparable sales (comps) for the restaurant industry as a whole, making the mood somber. This is further reflected in the industry's stock-price performance. Over the past year, the stock-price performance of the Zacks classified Retail-Restaurants industry compared unfavorably with the broader S&P 500 index. While the industry stocks gained a mere 2.2%, the broader index was up 13.4%.
Despite the loud buzz about the restaurant industry hitting recession, it is to be noted that sustained strength in the labor market on the back of a steady rise in wages will likely encourage consumers to dine out more. Restaurateurs are undertaking various sales building and digital initiatives to drive traffic and comps. Also, they are increasingly adapting to the changing tastes and preferences of their consumers to entice them once again.
Increased focus on refranchising bodes well while remodeling efforts should enhance guest experience. Moving ahead, the restaurant industry is thus positioned to get its mojo back.
What's Spooking the Restaurant Industry?
Restaurants have been witnessing solid sales growth ever since the Great Recession and 2016 wasn't any exception. Moreover, in its 2017 Restaurant Industry Forecast, the National Restaurant Association revealed that it expects sales in the restaurant industry to reach $799 billion. So, then what's really bothering the industry?
It is to be noted that though this will mark the eighth consecutive year of real growth in restaurant sales, the rate of growth continues to be limited. Additionally, even though total sales are up, foot traffic at individual restaurants is waning fast.
Same-store sales that account for traffic dropped in each of the four quarters of 2016 (0.2%, 0.7%, 1.1% and 2.4%, respectively), per TDn2K's Black Box Intelligence. In fact, the 2.4% fall in Q4 was the worst experienced by restaurants in over five years. Also, same-store sales declined 1.6% in the first quarter of 2017, highlighting the difficult operating environment currently facing many operators.
We note that the prime reason for such a drop in same-store sales is essentially the increased number of new restaurants amid restricted growth in eating-out budgets. Supply glut and limited demand are thus hampering traffic as well as stock prices for restaurants as instead of generating added sales, each new restaurant is eating up share from other restaurants. This has in fact resulted in bankruptcy for many public and private restaurants.
Another major challenge that restaurants are facing of late is increase in menu prices at a much quicker rate than the prices for food at grocery stores. This is adding to the competitive pressure for restaurants, as preparing food at home has become much more attractive from a cost perspective.
What Can Possibly Drive Growth?
Nevertheless, some of the big names like McDonald's Corp. (NYSE: MCD - Free Report ), Domino's Pizza, Inc. (NYSE: DPZ - Free Report ), The Wendy's Company (NASDAQ: WEN - Free Report ), Darden Restaurants, Inc . (NYSE: DRI - Free Report ) and Restaurant Brands International, Inc. (NYSE: QSR - Free Report ) seem to be unperturbed by the plight and continue to do well on the back of strong fundamentals and innovative offerings. While McDonald's, Domino's and Papa John's carry a Zacks Rank #3 (Hold), Darden holds a Zacks Rank #2 (Buy). Restaurant Brands sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here .
This signifies that all is not lost for the U.S. restaurant space and investors should thus not shy away from putting money into this space and cash in on the bountiful opportunities.
In fact, long-term trends favoring eating out over eating at home are still in place. Moreover, operators willing to evolve and stand out in a competitive market will continue to reap profits. Thus, restaurants with solid fundamentals and sufficient capacity for innovation will remain compelling bets.
More importantly, long-term factors supporting the sector remain firmly in place. Per the USDA, spending on food outside homes has risen from 10% to 50% of total food purchases over 1904 to 2013. In addition, sales at food services and drinking places have increased more rapidly than retail sales since 20+14. This trend is also far more stable and will continue to lift the sector once the current weakness subsides.
Wave of Consolidation
Consolidation is the name of the game to survive the prevailing restaurant recession. Evidently, though it's just the fourth month of the year, we have already witnessed four noteworthy M&A activities in the restaurant space.
Notably, another vital rationale behind these consolidations is rising labor expenses and other costs. Now that the Affordable Care Act is here to stay, restaurateurs could be looking to increase scale of operations so as to benefit from economies of scale. Additionally, consolidation is convenient for overseas expansion.
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