Here are highlights from the Zacks Industry Outlook for Restaurant Stocks:
The restaurant stocks industry is showing improvements and seems poised for long-term growth, but concerns about the health of the U.S. economy and the nagging sovereign debt issues in Europe pose some risks to this outlook. However, if we look back at the last few months, restaurant operators managed to post improved results riding on the back of modest traffic improvement and the consequent rise in comparable-store sales.
Road Ahead for Restaurant Stocks
Looking ahead, we see modest top-line trends for restaurant stocks. Most of the restaurant operators are passing on higher costs to consumers in order to mitigate commodity pressure this year, and we expect this trend to continue in 2012. The restaurant stocks that are well positioned are likely to enjoy pricing power and thus same-store sales increases.
However, we expect guest count for restaurant stocks to remain subdued in the first half of 2012. The U.S. economy is improving, albeit at a lower rate, but a sluggish labor market, over-supply of restaurant stocks in the industry, higher gasoline prices, food cost inflation, a still-elevated unemployment level and weak income growth may weigh on restaurant stocks industry profitability.
Drivers of the Restaurant Stocks Industry
The U.S. restaurant stocks industry consists of Quick Service Restaurants (QSR), Midscale Restaurants, Casual Dining, Non-Commercial and Fine Dining/Upscale restaurants.
In the midst of what might be called a lukewarm recovery, these are the potential drivers of net income growth for the restaurant stocks industry: unit expansion, same-store sales, cost-containment efforts and marketing tools.
Unit Expansion: Emerging from a lackluster economy in 2008-2009, most of the companies have accelerated their pace of restaurant openings, though not aggressively. A relative recovery in consumer confidence has also encouraged restaurant stocks companies to return to unit expansion.
In fact, the restaurant stocks companies are also exploring international markets. While Chipotle is primarily concentrating on European countries including U.K., Germany and France, Buffalo Wild Wings Inc. (BWLD – Snapshot Report) will expand its overseas footprint by opening more than 50 company-owned and franchised restaurants in Canada over the next 5 years. Additionally, the company is also looking for expansion opportunities in other international markets like the United Kingdom and Middle East. Another restaurant, P.F. Chang's China Bistro Inc. (PFCB - Snapshot Report) is also eying the Canadian restaurant stocks market.
Darden Restaurants Inc. (DRI – Snapshot Report) will also spread its operations in the Middle East. Several food chains, including Denny's Corp. (DENN - Snapshot Report), Pollo Tropical of Carrols Restaurant (TAST - Snapshot Report) and Starbucks Corporation (SBUX – Snapshot Report) intend to tap the fast-growing Indian market. McDonald's Corp. (MCD – Snapshot Report) and Yum! Brands Inc. (YUM – Snapshot Report) already have considerable coverage in India. Restaurant stocks companies like Yum! Brands and McDonald's are aggressively expanding in China to capitalize on the fast-paced economic growth in Asia. The restaurant stocks companies are also targeting South-East Asia for expansion.
With the economic outlook improving, the fortunes of a number restaurant stocks industry players have turned around. These restaurant stocks companies promise long-term growth opportunities.
Buffalo Wild Wings (BWLD – Snapshot Report) offers investors one of the strongest growth stories in this space. It had also been able to consistently deliver positive comps during the height of market turmoil.
With steady restaurant stocks earnings and a healthy balance sheet, McDonald's (MCD – Snapshot Report) provides relative safety and moderate growth opportunities in the current scenario, as well as exposure to faster-growing international markets. McDonald's U.S. comparable-store sales have been showing a continued uptrend since the last few months on strong sales of beverage as well as core menu products.
Boasting of a unique position in the hyper-competitive bar and grill segment, yet another stock, BJ's Restaurants (BJRI – Snapshot Report) offers investors a strong growth story for restaurant stocks with a viable business strategy and debt-free balance sheet. The restaurant stocks company delivered impressive second quarter results in terms of earnings per share and same-store sales growth.
Improved Californian Market for Restaurant Stocks
The core California market, which was badly hit by the recession resulted 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 and Red Robin Gourmet Burgers Inc. (RRGB – Snapshot Report) are expanding rapidly in California.
Job Growth in the Sector for Restaurant Stocks
The restaurant stocks industry is one of the major contributors to job growth in the U.S. In the 12 months ended October 2011, restaurant employment increased 1.7% from 1.1% for the same period a year earlier. According to the National Restaurant Association, Texas and Florida will likely show the strongest job growth over the next 10 years.
M&A Restaurant Stocks Activity
Merger and acquisition activity is also gaining momentum in the sector for restaurant stocks. The restaurant stocks companies are looking at potential business partners to foray into different zones and unlock value. While Starbucks has stepped beyond coffee and ventured into the $50 billion category of healthy juices, Yum! Brands is also on the verge of acquiring China-based restaurant chain Little Ship. Recently, the Minneapolis-based Granite City Food & Brewery agreed to acquire the assets of seven Cadillac Ranch All American Bar & Grill restaurants. Darden has also inked a deal to purchase two Eddie V's restaurant brands –– Eddie V's Prime Seafood and Wildfish Seafood Grille.
Apart from acquisitions, the restaurant stocks companies are also divesting their slow-moving brands in order to spur growth. The recent sale of Long John Silver's and A&W of Yum! Brands as well as the departure of Arby's from Wendy's confirm the trend.
Currently, there are a number of restaurant stocks in the restaurant with a Zacks #1 Rank (short-term Strong Buy rating). These include Domino's Pizza Inc. (DPZ - Snapshot Report). Companies with Zacks #2 Rank (short-term Buy rating) include Benihana Inc. (BNHN - Snapshot Report), Panera Bread Co. (PNRA – Snapshot Report) and Papa John International (PZZA - Snapshot Report).
Food costs account for about one-third of restaurant sales. Wholesale food prices have been on the rise this year. Prices of corn, wheat, coffee and other commodities have also trended up, compelling many restaurants to raise prices on some of their products. The restaurant stocks are expecting industry-wide increases in commodity and energy costs to continue in 2012. Dairy and beef prices witnessed a steep rise on a year-over-year basis.
Lag in Traffic Growth Barring Fast Casual Restaurant Stocks
According to a recent NPD foodservice market research report, visits to the leading fast casual restaurant chains grew more than 15% over the last three years while the rest of the industry experienced its sharpest traffic declines. However, fast casual unit availability increased 12% since 2007. Visits to the leading fast casual restaurant chains, like Chipotle (CMG – Snapshot Report) and Panera, were up 6% for the year ending December 2010 versus a year ago. This compares with a 1% decline in total industry visits for the same time period.
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 restaurant stocks outlook. These include Brinker International Inc. (EAT - Snapshot Report), Yum! Brands, The Cheesecake Factory, Einstein Noah Restaurant Group Inc. (BAGL - Snapshot Report) and McDonald's, all of which retain the Zacks #3 Rank (short-term Hold). Ruby Tuesday Inc. (RT - Snapshot Report) and Jack in the Box Inc. (JACK - Snapshot Report) still hold the Zacks #4 Rank (short-term Sell).
The restaurant stocks industry is still not immune to uncertainties in the macro economy. We believe the restaurant stocks companies with strong cash flow generation will survive the market volatility. However, there are restaurant stocks companies with huge capital budgets that look to be in good shape financially. Easy comparisons from the prior year will likely place this year's performance in a brighter light.
On the consumer front, while they were previously struggling to survive in a recessionary environment, restaurant stocks are now grappling with steeply rising commodity costs, a still-high unemployment rate and dreary wage gains. These factors are still compelling consumers to tighten their belts. In our opinion, a set of focused efforts will help restaurant stocks companies operate with a cautiously optimistic outlook for restaurant stocks in 2012.
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