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Restaurant Stocks Show Fed May Ease More on Spending Doubt

Patrons dine at a Cheesecake Factory restaurant in Denver. Photographer: Matthew Staver/Bloomberg
Patrons dine at a Cheesecake Factory restaurant in Denver. Photographer: Matthew Staver/Bloomberg

Full-service chains owned by Darden Restaurants Inc. and Brinker International Inc. are underperforming as investors bet on a slowdown in dining out, a signal to the Federal Reserve to do more to bolster consumption.

The Bloomberg Full Service Restaurant Index, which includes Cheesecake Factory Inc., Darden and Brinker, has fallen 21 percent since July 5, while the Bloomberg Quick Service Restaurant Index -- made up of fast-food chains such as McDonald’s Corp. and Wendy’s Co. -- has declined 5 percent. The difference indicates Americans may treat themselves to fewer sit-down meals away from home, according to Todd Hooper a San Francisco-based restaurant strategist at consulting company Kurt Salmon.

“Both sectors are down, and this shows the stock market is concerned we’re either in for a double-dip recession or at least another slowdown,” Hooper said. “If the market is right, full-service restaurants, because they are more discretionary than quick-service, will take the brunt of weaker consumer spending.”

This is “a signal by investors to the Fed that additional monetary accommodation is needed to support the U.S. consumer,” said David Rosenberg, the chief economist at Gluskin Sheff & Associates in Toronto. With a deteriorating labor market deterring purchases, “investors are concerned that consumer frugality may take on a new head of steam, which helps explain why full-service eateries are falling out of favor now.”

‘Unexpected’ Weakness

Most Federal Reserve policy makers indicated at their August meeting that household-spending weakness in recent months was “unexpected.” Since peaking at an annualized increase of 3.2 percent in November 2010, personal consumption expenditures adjusted for inflation slowed to 2.3 percent in July, according to the Bureau of Economic Analysis. Spending on restaurants and accommodations rose 2.9 percent annually in July compared with 5.1 percent in November.

One-third of Americans said they plan to spend less on dining out during the next 90 days, the highest since October 2010, according to a monthly survey of 2,517 consumers conducted by RBC Capital Markets. Along with higher savings intentions, this “could portend slowing restaurant sales,” said Larry Miller, an RBC analyst in Atlanta.

Political ‘Stalemate’

“Concerns about the economy and the political stalemate in Washington contributed to these weaker spending plans,” Miller said. Full-service eateries were “hit the hardest,” as 22 percent of companies in another RBC survey reported a “large negative impact” to their sales, compared with 5 percent of quick-service operators.

What remains to be seen, Miller said, is whether consumers are having a “psychological reaction” to recent political events and stock-market volatility, which may cause a temporary sales slowdown, or if weak employment data is resulting in lower restaurant sales.

Protracted joblessness -- above 9 percent for 26 of the past 28 months -- means dining out is “often first on the chopping block,” Hooper said.

Weaker-than-expected sales at the Olive Garden -- down 2.9 percent in the three months ended Aug. 28 -- contributed to Darden missing analysts’ projections for first-quarter profit, according to Miller. The Orlando, Florida-based operator of the Red Lobster and Olive Garden chains said profit from continuing operations was 78 cents a share, according to a Sept. 6 statement of preliminary earnings; the average of analyst estimates was 87 cents.

Disappointing Results

While Olive Garden’s disappointing results may show consumers are starting to cut back, Darden’s preliminary August sales indicate “the consumer hasn’t significantly reduced spending yet,” Miller said. Same-restaurant sales for the Olive Garden, Red Lobster and Longhorn were up 2.1 percent, in line with the growth during the past four months.

“It’s a glass half-empty, glass half-full kind of report,” said Miller, who maintains an “outperform” rating on Darden.

Conversely, more people are eating at quick-service chains, which translates into higher revenue. System-wide same-store sales at Jack in the Box Inc. restaurants increased 3.2 percent in the three months ended July 10, the San Diego-based company said Aug. 10.

“Sales momentum including higher traffic” has continued into the fourth quarter, President and Chief Executive Officer Linda Lang said on an Aug. 11 conference call.

Rising Sales

Similarly, sales at company-owned Wendy’s restaurants in North America rose 2.3 percent in the three months ended July 3 compared with a year ago, driven by 1.4 percent higher average checks and a 0.9% increase in transactions, President and Chief Executive Officer Roland Smith said on an Aug. 11 conference call.

“We’re starting to see more customers in the store and our check was up slightly,” Smith said. “So we’re also seeing them spend more money.”

While this helps explain some of the relative outperformance of quick-service dining stocks, there is also a seasonal trend at play, according to Steve West, a St. Louis-based analyst at Stifel Nicolaus & Co. Vacationing Americans tend to eat more fast food during summer months, which temporarily boosts sales -- and shares.

Seasonal Business

Some restaurants may enjoy higher seasonal business, even though real personal income still lags behind the 2007 total by about $450 billion. As a result, consumers remain cautious because they’re living in a “muted recovery,” according to John Herrmann, senior fixed-income strategist at State Street Global Markets LLC in Boston. Even the Fed holding interest rates near zero since December 2008 has done little to stimulate spending in a “subpar” recovery, he said.

“The only thing to help accelerate sales and to place sales on a sustained trajectory is for households to acquire a stronger conviction about job security, income growth and the government-policy outlook,” Herrmann said. “Consumers remain nervous as the economy will have to stand on its own two feet with increasingly less fiscal support beyond 2011.”

Some policy makers on the Federal Open Market Committee said at their August meeting that “additional accommodation was warranted,” while others “judged that none of the tools available to the committee would likely do much to promote a faster economic recovery.”

Fed Forum

Even Chairman Ben S. Bernanke acknowledged that the Fed alone can’t keep the recovery afloat in an Aug. 26 speech to central bankers and economists at an annual forum in Jackson Hole, Wyoming.

“Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank,” he said.

President Barack Obama, speaking before a joint session of Congress yesterday, challenged lawmakers to pass a $447 billion jobs plan that would boost spending on infrastructure, stem teacher layoffs and cut in half the payroll taxes paid by workers and small business owners.

“The question is whether, in the face of an ongoing national crisis, we can stop the political circus and actually do something to help the economy,” Obama said.

Persistent concerns about growth suggest that restaurant sales could continue to slip as autumn approaches, according to Hooper.

“The expansion is showing signs of stalling,” Hooper said. “So full-service restaurants are vulnerable to additional underperformance compared to their more defensive quick-service counterparts.”

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