Outback Appears To Be Out Of Luck (OSI, DRI, MRT, CAKE)

Restaurant chain Outback Steakhouse (OSI) was upgraded this morning by Morgan Stanley.

We're less optimistic about Outback's prospects. The steak space is getting too crowded for our liking and Outback's newer concepts (like Bonefish Grill) are far less proven to bet the ranch on.

We expect Outback will continue to tread through choppy waters for the remainder of 2006. This stems from our view that there really is no Outback brand visibility -- one recent channel check confirmed that Outback has low "stickiness factor," especially within its steakhouse segment, whose 900 restaurants comprise the bulk of Outback's sales.

Outback continues to suffer from below industry margins, as well. Its balance sheet is anything but clean ($44M cash paired with $200M in debt & leases). And a recent management change (the founders left) may still have some investors on edge.

Our restaurant pick remains Darden Resaurants (DRI), which we brought your attention to last December (with the stock at $35). Darden enjoys modest growth, double digit operating margins, and heightened brand awareness. We also like how Darden's CEO focuses on getting a lot of out what the company's already got (resulting in an impressive 25% ROE) and doesn't blame hurricanes for soft sales.

2006 will be a litmus test year for Outback, which could easily topple under an economic downturn, rapidly evolving consumer tastes, and the spillover effects associated with higher commodity prices (crimping margins even further). Because Outback isn't in the position to leverage off its name, the stock could quickly deteriorate under strenuous conditions.

If steak is your thing, we suggest a look at Morton's (MRT) -- we like the 13% operating margins they've been spitting out. If you want growth, look no further than Cheescake Factory (CAKE), which operates at full capacity and has massive room to grow. Cheesecakes's strong niche, furthermore, makes its less susceptible, in our opinion, to earnings erosion in the event that the restaurant industry stumbles.

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