Casual-Dining Stocks Attract Bets as Sales Lag: EcoPulse
Investors bullish about American consumers are eyeing shares of some restaurants, even as the industry reels from a tough winter.
Famous Dave’s (DAVE) of America Inc., Kona Grill Inc., Buffalo Wild Wings Inc. and Del Frisco’s Restaurant Group Inc. -- members of the Bloomberg U.S. Full-Service Restaurant Index -- have outpaced the Standard & Poor’s 500 Index by an average of 84 percentage points in the last 12 months.
This shows investors have bid up companies perceived as “fast growers” in terms of same-store sales and adding outlets, according to Marty Leclerc, founder and chief investment officer of Barrack Yard Advisors, which oversees $270 million in Bryn Mawr, Pennsylvania. That probably will continue, as investors try to identify areas of strength in an increasingly fragmented industry, he said.
The four biggest laggards in Bloomberg’s full-service restaurant index -- Ruby Tuesday Inc., Bravo Brio Restaurant Group Inc., Ignite Restaurant Group Inc. and BJ’s Restaurants Inc. -- have trailed the S&P 500 by an average 30 percentage points in the last 12 months.
The stocks that already lead the market probably will remain in favor, Leclerc said, adding that now is “a decent time in the economic cycle” to consider buying.
Such bullishness comes amid a slowdown in the casual-dining industry, as sales fell 1.5 percent in February, following declines of 2.3 percent the prior month and a combined 2.8 percent in November and December, according to the Knapp-Track Index. Sales contracted in seven of the past nine months, and preliminary data suggest March wasn’t as strong as last year’s 2.6 percent gain, said Malcolm Knapp, a New York-based consultant who created the index and has monitored the industry since 1970.
Harsh winter weather was a “real problem” for these companies, though eating out generally hasn’t been very robust, he said. Restaurants also are engaged in a market-share fight, so “the trick is to provide affordable food for those consumers who are constrained, at somewhat better quality and prices.”
Successful operators are “more in tune” with customers who grapple with economic and social changes that create stress and make their eating-out pattern unpredictable, Knapp said.
“The consumer is skittish still; they’re just not as confident,” Chief Executive Officer Wyman Roberts said at a March 12 conference hosted by RBC Capital Markets. Meanwhile, the industry faces “a continued oversupply of restaurants,” Stuart Brown, chief financial officer of Red Robin Gourmet Burgers Inc. (RRGB), said on a Feb. 14 conference call.
Even with these challenges, several full-service restaurant stocks appeal to investors as a “direct way to bet on a recovering U.S. consumer,” said Will Slabaugh, an analyst in Little Rock, Arkansas, at financial-services company Stephens Inc. He maintains overweight recommendations on seven such companies including Minneapolis-based Buffalo Wild Wings and Del Frisco’s (DFRG), in Southlake, Texas.
Slabaugh’s “best idea” for investment this year is Del Frisco’s, which generates at least half its revenue from corporate diners and benefits from a customer base he says is generally better off financially than that of many competitors. Del Frisco’s also is expanding, which appeals to investors, he said. The chain plans to open five Del Frisco’s Grilles and one Double Eagle restaurant this year, it said in a Feb. 26 statement.
The company’s first quarter was off to a “slower start” than expected, though foot traffic was up, particularly on days when weather wasn’t an issue, Chief Executive Officer Mark Mednansky said on a conference call that day. “The upscale consumer is not only coming out, but they’re a little more active with their pocketbook.”
For low- and middle-income diners, Buffalo Wild Wings (BWLD)’ sports-bar themed restaurants provide an “affordable luxury,” Slabaugh said. The chain also is expanding, another reason he likes the stock. Buffalo Wild Wings said Feb. 4 it planned to open nine company-owned restaurants in the first quarter.
Among the fastest-growing companies, it is “the only one that intrigues” Leclerc. That’s because Americans’ love of sports helped buoy sales even as many of its competitors blamed harsh weather for a sluggish first quarter, he said.
Even so, its shares are “pretty rich” for his portfolio preferences, trading at about 30 times earnings on a forward-looking basis, compared with about 15.5 times for the S&P 500, Leclerc said. While the company doesn’t appeal to him, it offers other types of investors a “good bet, if you’re willing to pay high multiples.”
Another group -- restaurants with solid sales track records -- could be poised to attract additional investment this year, Leclerc said. Frisch’s Restaurants Inc. (FRS) is an interesting option for long-term value investors, he said, adding that his firm recently sold its holding after the stock traded above $25 in late December. Cracker Barrel Old Country Store Inc. (CBRL) also is the type of company that’s appealing because it’s a “quality business selling at a reasonable price.”
Many American consumers face “negative or moderately positive” wage growth and hiring prospects this year, so they may not be willing to pay more when they dine out, Slabaugh said. As a result, some restaurateurs could have difficulty charging more.
Average earnings for U.S. private-sector employees rose 2.2 percent in February from a year ago to a seasonally adjusted $24.31 an hour, according to Labor Department data. This measure of wage gains has averaged 2 percent growth since the 18-month recession ended in June 2009 after peaking at 3.9 percent in June 2007.
Nonfarm payrolls expanded 200,000 last month, based on the median estimate of economists surveyed by Bloomberg, compared with 2013’s monthly average of 194,250, Labor Department figures show.
Famous Dave’s is “very sensitive” about raising prices, Chief Financial Officer Diana Garvis Purcel said on a Feb. 13 conference call. Similarly, Columbus, Ohio-based Bravo Brio is cautious about casual dining in 2014 after many “aspirational, more sensitive guests were either enticed by competitive discounting or simply stayed home,” Chief Executive Officer Saed Mohseni said on a Feb. 24 conference call.
As temperatures rise, Americans with “cabin fever” are eating out more again, Slabaugh said. In addition, “consumers have been pretty careful with their money, so if the economy continues to improve, this type of spending will go up,” Leclerc said.
While some of the industry’s “gloom and doom” has been overstated, investors need to be patient as some companies are making big changes in an effort to boost sales, Knapp said. In the meantime, the casual-dining market is growing, albeit slowly, and successful restaurants will appeal to two groups: consumers on a budget and those with “a little more flexibility.”
“Restaurants are trying to figure out how to do premium products to appeal to the higher-end consumers, while still offering a value proposition,” he said.
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