Steak Chains: Sirloin or Chopped Liver?
By Eric Wahlgren
The first reported case of mad cow disease in the U.S. has turned out to be a big so-what for steak lovers and the restaurants that cater to them. Stocks of steak-house chains fell as much as 5% on December 24, 2003 -- the day after news broke that a dairy cow in Washington State had tested positive for the deadly brain-wasting disease.
Shares have since rebounded as Americans continue to order prime rib and filet mignon. Among the reasons? The case of bovine spongiform encephalopathy -- the medical name for mad cow -- appears to have been isolated, thanks to the swift response of U.S. authorities, who destroyed the entire herd to stop any crisis of confidence over American beef. It was later revealed that the hapless Holstein was actually born in Canada.
"We and other companies have said in press releases that we haven't seen any material impact on sales, and that still seems to be true," says Alan Mandel, chief financial officer Smith & Wollensky (SWRG ), an upscale steak-house chain based in New York City. Thanks in part to the improving economy and the widespread appeal of the Atkins diet and similar high-protein regimes, people are still flocking to eateries that serve steak, especially high-end restaurants.
Smith & Wollensky says sales jumped nearly 12% in its fourth quarter at restaurants open at least 15 months. Del Frisco's Double Eagle Steak House, a top-shelf chain owned by Wichita-based Lone Star Steakhouse & Saloon (STAR ), saw a jump of nearly 14% in fourth-quarter sales at outlets open at least 18 months.
Also boosting sales is the gradual recovery in business lunches and convention travel that has come with the rosier economic outlook, analysts say. Many of these chains' highest-volume restaurants are in key tourist meccas, including New York, Chicago, and Las Vegas, where diners aren't shy about charging a salad and a piece of dry-aged beef on their expense accounts. The more exclusive restaurants "are going to be more sensitive to the pickup in business spending," says Michael Gallo, an analyst with C.L. King & Associates in New York.
However, before you consider adding some beef to your portfolio, note that stocks of many fancier steak joints have already bulked up over the past year. Smith & Wollensky shares are up 108%, to $7.31, since the beginning of 2003, and shares of Lone Star have risen 36%, to $26.27, in the same period.
Shares of Tampa-based Outback Steakhouse (OSI ), which also runs the tonier Fleming's Prime Steakhouse & Wine Bars, have increased 26%, to $43.44, in the past year. And Landry's (LNY) -- which remains primarily a seafood chain despite buying Chart House and Saltgrass Steakhouse in 2002 -- has gained 22%, to $27.35.
Another consideration: Despite rising sales, profit growth at several outfits remains weak, and in some cases, nonexistent -- in part because robust demand for beef has pushed up meat prices. At $139.68 per 100 pounds on Jan. 16, beef costs nearly 15% more than it did a year ago. Prices have dropped some 4.5% since the mad cow news, but that's of little benefit to steak chains, as most had already locked in prices for several months, says Dennis Milton, a Standard & Poor's equity research analyst in New York, who adds: "They may benefit later as they renegotiate their pricing."
Some steak-restaurant bulls haven't given up. Gallo likes Landry's, which announced on Jan. 9 that it expected fiscal year 2003 revenue to be about $1.1 billion, 23% higher than the prior year, and that operating profit would meet or top analysts' expectations. Wall Street is expecting the outfit to earn $1.74 a share in 2003, a 13% increase over the previous year, according to First Call/Thomson Financial.
"I look at price value, and the company is still one of the cheapest restaurants in the group," says Gallo, who rates Landry's a strong buy and has assigned it a $30 target price, which suggests a 9% gain in the next 12 months. By Eric Wahlgren Mike Smith, an analyst with Oppenheimer & Co. in Kansas City, rates Landry's a buy, saying the stock could rise 20% to 30% in the next 12 months. Although Landry's Saltgrass acquisition was small, he hails the Saltgrass concept as "a little bit more up-to-date" than other steak houses.
A better bet, thinks Smith, is Lone Star, which is expected to earn $1.06 in fiscal year 2003, or 29% less than in 2002, on essentially flat revenues of $611 million, according to First Call/Thomson Financial. Although Lone Star said it could not comment ahead of its earnings report -- expected the week of Feb. 5 -- its third-quarter earnings statement, issued September 29, 2003, noted that it continued to be hurt by higher costs for employee benefits and beef.
Smith rates Lone Star, whose holdings include five Del Frisco's and 268 Lone Star eateries, a buy. The optimistic rating is based in part on a possible uptick in business from an image makeover the chain is considering for its less tony Lone Star restaurants, says Smith. Gallo rates Lone Star accumulate, noting that it has successfully divested its Australian operations. What's more, says Gallo, Lone Star stands to gain from the dip in beef prices, since it is one of the few outfits that doesn't hedge. "They have the perfect storm," he says.
Outback is the leader in the more upscale steak-house segment, with 21 Fleming's and 814 Outback outlets, among other brands. Smith rates it a buy. The company is expected to earn $2.23 a share in fiscal year 2003, or nearly 10% more than in 2002, on 15% higher revenues of $2.72 billion, says First Call/Thomson Financial. "They can manage good growth rates," Smith says. (Neither Smith nor Gallo has ties to the companies they cover, nor do their firms.)
Much smaller Smith & Wollensky, which tends to attract an urban crowd, is recovering from a downturn that followed the September 11 terrorist attacks, says Dennis Forst, an analyst in Los Angeles with McDonald Investments, one of the few firms to follow the company. The chain is expected to lose 6 cents a share, vs. a 22-cent loss in 2002 on 21% higher revenues of $93 million, according to First Call/Thomson Financial.
Revenues for Smith & Wollensky should continue to grow as its newer restaurants, which have high fixed costs, mature, Forst says. But for now, he gives the chain a neutral rating. "The stock has moved up nicely, and we think the valuation is fair," says Forst, whose firm has an investment-banking relationship with Smith & Wollensky.
PAST THEIR PRIME?
S&P's Milton is concerned about valuation for Landry's and Outback. (He doesn't follow Lone Star or Smith & Wollensky.) He rates Landry's a hold and Outback avoid. "They are both good companies," says Milton, who has no ties to the stocks he covers. "But the current stock prices adequately reflect their growth prospects." Landry's wasn't immediately available for comment, and an Outback spokeswoman said it was against corporate policy to comment on analyst ratings.
Smith & Wollensky's Mandel thinks his company is a good bet for buy-and-hold investors. "We do a good job in terms of satisfying our customers and putting a very high-quality product on the table," he says. "Investors should evaluate whether we have a good management team and whether the team is making good decisions."
That's meaty advice for investors looking to dive into steak-house stocks, not just Smith & Wollensky's. But with many of the upscale outfits having rallied in the past year or so, investors may find beefier returns elsewhere.
Wahlgren covers financial markets for BusinessWeek Online in New York
Edited by Beth Belton