Dining out is about as discretionary a purchase as you’ll find. When consumers are feeling confident, you’ll find them crowding into restaurants. When they’re not, home-cooked dinners and brown-bag lunches are the order of the day.
The last recession was no exception: faced with surging unemployment, a crumbling real-estate market and plunging stock prices, many people quickly decided that restaurant meals no longer fit into their budgets. According to market research firm IBISWorld, restaurant revenue fell 3.4% in 2009, to $77.5 billion.
The sluggish recovery has done little to help lure diners back: over the five years leading up to 2013, sales have climbed an average of just 1.5% annually. At the same time, consumer tastes have changed quickly, particularly when it comes to healthier and locally sourced food.
Recent polling by the National Restaurant Association illustrates both the shift and the industry’s response: 71% of respondents said they would be more likely to visit a chain offering locally produced food, while 86% felt there were healthier options available at restaurants than there were just two years ago.
From Famine to Feast?
Now there are signs the lean times may be fading. IBISWorld, for example, estimates that restaurant revenue rose 3.8% in 2013, to $86.6 billion—well above pre-recession highs.
Moreover, on December 31, the National Restaurant Association released its latest restaurant performance index (RPI) reading, and the trend continues to point upward.
The RPI, an indicator of the sector’s health and prospects, rose to 101.2 in November. That’s up 0.3% from October and its highest level since June. Any number above 100 indicates expansion, and November marked the ninth consecutive month the RPI was above that level.
During the month, 57% of restaurant operators reported a same-store sales gain compared to November 2012, up from 54% in October and the highest level in six months. Moreover, 47% reported increased customer traffic, up from 43% in October.
Confidence, too, edged up slightly, with 38% believing their sales would be higher in six months (compared to the same period the previous year), versus 36% who felt that way in October.
Three Restaurant Chains to Watch
It’s important to keep in mind that in addition to being highly cyclical, the industry is hotly competitive and fragmented. That often limits restaurants’ ability to pass price increases on to consumers: for example, wholesale food costs rose 2.3% in November from a year ago, faster than menu prices, which increased 2.1%.
Below are three examples of chains that are doing a good job of improving their sales, controlling costs and navigating fickle consumer tastes.
Chipotle Mexican Grill (NYSE: CMG) has jumped 25% in the three months since Investing Daily analyst Brian O’Connell flagged it as an attractive pick in an October 8 article.
“For a so-called ‘fast food’ company, Chipotle offers high-quality food that’s both speedily prepared and swiftly served, and the restaurant uses top-notch ingredients,” he wrote. “You do that on a regular basis, and it’s no wonder your revenues grow 18% annually and you have opened 1,500 restaurants across the U.S. The public has spoken, and it loves Chipotle.”
The company follows its “food with integrity” mantra, which involves emphasizing organically grown produce and naturally raised beef. That helps it stand out from other chains, but it also means higher ingredient costs (33.6% of revenue in the latest quarter).
Chipotle continues to add to its offerings: it recently partnered with two restaurateurs to launch Pizzeria Locale, a pizza outlet in Denver that also uses all-natural ingredients. It may open two more. The company also recently began offering catering.
The stock is not cheap, at around $530. It also trades at a high 41.4 times Chipotle’s forecast 2014 earnings of $12.70 a share. However, the company’s focus on all-natural foods and expansion (it plans to open 165 to 180 outlets this year) put it in a great position to grab market share as restaurant sales rise.
Dunkin’ Brands Group (NYSE: DNKN) doesn’t immediately leap to mind as a restaurant stock, but the Massachusetts-based coffee-and-doughnut chain continues to add new menu items aimed at attracting more than just the morning crowd.
As Investing Daily Editorial Director John Persinos reported in a September 16, 2013, article, Dunkin’ Donuts has significantly expanded its menu, with more elaborate items, such as roast beef, turkey sausage and steak sandwiches, as well as tuna and chicken salad wraps. It’s also offering more gluten-free fare.
Persinos sees many other reasons to be bullish about the company’s prospects. For one, its concentration in the Northeast gives it a strong foundation from which to pursue its expansion into the rest of the U.S., including the West Coast.
There are about 7,500 Dunkin’ Donuts outlets in the U.S., but the company believes there’s room for 15,000, including 3,000 more east of the Mississippi River and 5,000 in the west. As well, its outlets are all run by franchisees, which helps keep a lid on costs.
The stock sports a forward p/e ratio of 26.40, slightly above main competitor Starbucks (NasdaqGS: SBUX), at 24.46, and about on par with Krispy Kreme (NYSE: KKD), at 26.36. The $0.76 dividend yields 1.60%.
McDonald’s Corp. (NYSE: MCD): Any article on restaurant stocks would be incomplete without mentioning the fast-food giant. It’s far and away the biggest chain in the U.S., with 2012 sales of $35.6 billion, dwarfing No. 2 competitor Subway, at $12.1 billion. McDonald’s has about 35,000 outlets in 120 countries.
The company’s shares rose 8.5% in 2013, well behind the S&P 500, which notched a 30% gain. Earnings missed expectations in the second quarter, and CEO Don Thomson said McDonald’s results for the rest of 2013 would remain “challenged” due to the sluggish global economy.
Despite its lackluster 2013, the company still has plenty of investment appeal. For example, the shares are relatively stable, with a beta rating of just 0.33, meaning they’re about a third as volatile as the overall market.
McDonald’s also pays a dividend of $3.24 annually, for a 3.40% yield, well ahead of competitors likeWendy’s (NasdaqGS: WEN) at 2.30% and Yum! Brands (NYSE: YUM) at 1.90%. It’s also a frequent buyer of its own stock. Between dividends and buybacks, it expected to return $4.5 billion to $5.0 billion to investors for all of 2013.
Moreover, as O’Connell mentioned in a December 31 analysis of the company, its continued menu innovations should help improve its performance. For example, it is currently testing a build-your-own-burger concept to fend off competition from fast casual chains like Chipotle.
In addition, McDonald’s continues to add lighter options to its menu. For instance, it now sells egg-white McMuffins and plans to give customers the option to replace french fries with salads and fruit in all of its value meal selections this year.
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