Restaurant
Stocks Look Attractive
The Continued Popularity
of Dining Out
Bodes Well for the Shares of this Group
By Dennis Milton
Standard & Poor's The Outlook
Consumer
discretionary stocks have recently been struggling after weak
economic data renewed fears that the United States may be headed
for a "double dip" recession. Although restaurant stocks
fall into the discretionary category, recent trends indicate
that dining out has become a more integral part of American culture.
According to industry
consulting firm Technomic, the top 100 chain restaurants increased
overall sales by 5.1% in 2001, after a similar increase in 2000,
despite a weaker economy and the events of September 11. Moreover,
demand remained strong during the first six months of 2002. This
suggests that the group has become less sensitive to economic
conditions than other consumer discretionary segments. We expect
the industry, and particularly those companies with value-oriented
offerings, to continue to do well even in the face of additional
economic weakness.
The recent sales performance
in the restaurant industry is not surprising, given the long-term
trend in the United States toward eating out. According to the
Department of Agriculture, consumption of food away from the
home accounted for 47.4% of total food expenditures in 2001,
up from 45.4% in 1990 and only 26.3% in 1960. Factors such as
greater disposable income and a significant decline in the price
difference between dining out and cooking at home make the tendency
likely to continue. Boosting the trend toward dining out is the
reduction in free time for most Americans. In many families,
both parents have full-time jobs, which leaves them less able
to spend the substantial time it takes to prepare meals from
scratch. With more than half of mothers in the United States
working, and numerous moderately priced restaurants to choose
from, dining out is often the most convenient choice.
Technology is slowly
making its way into the restaurant business, which will provide
greater efficiency in the future. Computer software for labor
scheduling and accounting has been around for some time. However,
technology is now being applied in ways that enhance customer
convenience, improve sales and cut costs. An example of this
is cashless payment through proprietary debit cards.
Restaurant profitability
has been especially strong this year, benefiting from the relatively
low rates of industry expansion over the past several years,
lower food and utility costs, modest wage inflation and reduced
interest rates. In addition, the weakened employment outlook
across the country has enabled restaurants to reduce their employee
turnover rates, which decreases the costs associated with training
new staff. We expect these favorable conditions to continue for
at least the next 18 months.
Aside from strong fundamentals
and increased profitability, restaurant companies boast several
other traits that are attractive, given the recent stock market
volatility. They generally have admirable earnings quality, predictable
cash flows and solid balance sheets.
From the beginning of 2002 through August 2, the S&P restaurant index was off 5.1%, against a 24.7% slide in the S&P 500 and a 26.5% decline for the S&P consumer discretionary index.
Although the relative performance is impressive, restaurant stocks have recently been caught in the downdraft that has taken hold of the overall stock market. For the 13 weeks ended August 2, the S&P restaurant index lost 17.8%.
Based on increasingly strong industry fundamentals and impressive earnings growth, we believe the recent sell-off has created an opportunity to acquire quality restaurant company shares at attractive valuations.
Our current favorites in the industry group rated 5 Stars are: Applebee's International (APPB $21), and Wendy's International (WEN $37). 4 Star rated include: Cheesecake Factory (CAKE $30), CBRL Group (CBRL $26), McDonald's Corp. (MCD $23), Outback Steakhouse (OSI $30), P.F. Chang's China Bistro (PFCB $28), and Yum Brands (YUM $29).
Editor's Note: Dennis Milton is an analyst with Standard & Poor's The Outlook, 55 Water St., New York, NY 10041, 1 year, 48 issues, $298. Visit the web site at www.spoutlook.com.
