Restaurants Unprepared, Consumers Unwilling

Includes: DRI, MCD, SBUX
by: Adam Alvarez

In a little less than nine months, nearly every citizen in this country will be required to have health insurance or pay an initial penalty of either $95 or 1% of annual income, whichever is higher. Many companies will continue to cut hours and hire part-time workers in an effort to stay below the 30 hours a week in which the health care law requires employers to provide basic insurance or face a $2,000 penalty per worker. Meanwhile, the payroll tax cut will still be a thing of the past and more tax increases will undoubtedly be pushed, if not passed, amidst the next budget battle.

Such uncertainty amongst consumers has already hindered many businesses, but restaurants have thus far remained relatively unscathed. That is at least as far as share price goes.

Still, a barrage of problems ranging from rising gas prices to higher taxes have already battered many consumers these restaurants dearly depend upon. Add on the looming uncertainty regarding the upcoming months and these chains and their numbers are already staring at a rocky future. Some are already reporting disappointing figures.

Darden Restaurants (NYSE:DRI) recently reported third quarter earnings of $134.4 million or down 18% from the preceding year. Now the report did meet expectations, but that was after the company lowered forecasts back in February.

As for fast food chains, they appear better suited to endure a cutback in consumer spending. However, that doesn't make their shares sure winners. With McDonald's (NYSE:MCD) back challenging a $100 barrier shares failed to overcome at the beginning of 2012 and the company coming off a year in which earnings only grew 2%, buying shares here provides significant risk.

Also, McDonald's along with other fast food corporations such as Burger King Worldwide (BKW), Wendy's (NYSE:WEN) and Yum! Brands (NYSE:YUM) will be forced this year to find a perfect line between continuing to provide good prices while also still making a profit. That balance may prove illusive as oil prices remain within reach of $100 and as the U.S. Department of Agriculture projects a 3%-4% rise in food prices this year.

Now on the flip side, one of the few considered bright spots in the sector for analysts is Starbucks (NASDAQ:SBUX).

"One of our favorite stocks in the industry is Starbucks which has a luxury of catering to a more affluent customer base that probably is not as sensitive to the payroll tax issue," said RJ Hottovy, director of consumer equity research at Morningstar.

With earnings expected to grow 21% in 2013 and 22% in 2014, the company does provide much more in the way of security. However, with the stock already trading with a P/E ratio over 30 and such lofty earnings expectations hanging overhead, shares could crash hard depending on the next move by Congress.

Also, after falling 30% between April and July of last year, it might just make more sense to wait until Congress does make a move before placing a bet on shares.

After all, Darden Restaurants already has proven that even chains which cater to those more affluent classes aren't immune to cutbacks. In fact, Darden expects a 1.5%-2.5% drop in 2013 full year sales at its Olive Garden, Longhorn Steakhouse and Red Lobster branches after sales at those restaurants opened at least a year already fell 4.6% according to their latest report.

Now perhaps even more worrisome than the current numbers and cloudy outlooks is that many restaurants are now left looking for tax refunds to bring in customers.

"Hopefully, those tax returns coming in will give us a boost in terms of sales," said Darren Tristano, a restaurant industry analyst at Technomic, a market researcher. "Enough to offset, perhaps, the impact of the payroll tax cut."

However, if at the end of the first quarter restaurants continue to suffer the effects of the tax increase, to assume tax refunds will give consumers newfound buying power is rather dubious.

Also, the share prices of the majority of restaurants have already failed to reflect this tightening by consumers. In fact, Burger King, Wendy's, Starbucks, YUM! Brands, McDonald's, Bob Evans (NASDAQ:BOBE), Cracker Barrel (NASDAQ:CBRL), and Dunkin' Brands (NASDAQ:DNKN) all currently sit well within 9% of their 52-week highs. Therefore, meaning even a sudden spending spree may still do little for shareholders while continued cutbacks may prove devastating.

With the next round of tax increases and healthcare costs still in play, it would be safe to assume consumers would choose to instead tighten their wallets even further while using any tax refund to lower debt and not merely spend recklessly.

After all, if the payroll tax alone has hurt consumers and restaurants, what happens down the road may do much more damage.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.