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John A. Gordon is Principal and Founder of Pacific Management Consulting Group (http://www.pacificmanagementconsultinggroup.com), an independent restaurant analyst providing research and niche earnings analysis, management consulting and advisory expertise to those who need to know about chain... More
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  • 2013 Restaurant Themes: Comps Cliff Coming  1 comment
    Jan 9, 2013 1:57 PM | about stocks: MCD, SBUX, DRI, YUM, JACK, CMG, TXRH, BLMN, BWLD, PNRA, BKW, SONC, PLKI

    The restaurant space will be interesting in 2013. Sales issues, cost issues, expansion issues, franchisee issues. There are still too many restaurants in the US and x-US markets sales increases have slowed. The two industry leaders, McDonald's (NYSE:MCD) and Darden (NYSE:DRI), are both somewhat in the penalty box and under pressure. Here are our thoughts on 2013 issues and opportunities.

    Comps Cliff Coming: In looking at 2013, its likely restaurants will get off to a bad start. In Q4 and Q1 2013, the restaurant space will fall off a cliff of sorts: the comps generated last winter. Driven then both by warmer weather, price increases, a bit lower sales of discounted items and the peak of the 2010-2011 restaurant recovery, the January-March 2012 number will be hard to beat.

    The following chains will likely have the hardest sales comp comparisons in Q1. Every single chain had lower comps most recently reported than the Q1 peak:

    Company/symbolFY 2012, Latest Trend2012 Q1 Jan-March Comp
    McDonalds (MCD), worldwide+2.4% (November)+7.3%
    Starbucks (NASDAQ:SBUX), US+7.0% (9/2012)+9.0%
    YUM, China company units-6.0% (1/7/13 )+14.0%
    Jack in Box, JACK, system+3.1% (9/2012)+5.6%
    Chipotle, CMG+4.8% (9/2012)+12.7%
    Texas Roadhouse, TXRH+3.6% (9/2012)+5.8%
    Bloomin Brands, BLMN+3.6% (9/2012)+5.3%
    Buffalo Wild Wings, BWLD (system)+6.0% (9/2012)+9.1%
    Panera, PNRA (system)+5.8% (9/2012)+7.7%

    More sales news. In the QSR space generally, traffic now is very marginally positive and average check app. 2-3% favorable, but in the overall casual dining space, traffic is negative and totally offsets about a 2.5% check increase. There were a few standouts, however: TXRH, PNRA, SBUX, and AFCE.

    One question is why was investor disclose so poor at YUM? The China same store sales trend is so stunningly negative-large sequential decreases from +19% in FY-11 to -6% just noted this week for Q4 2012, perhaps the largest decline anywhere over such a short time.

    Extreme discounting is the newest news but is really old news. The current price spectrum of restaurant TV ads runs from $.99 grillers at Taco bell to $11.99 30 piece shrimp at Red Lobster. Doesn't portend well for average check. The comps cliff has affected marketing strategies everywhere.

    Earnings standouts: Texas Roadhouse (NASDAQ:TXRH), Panera (NASDAQ:PNRA), Starbucks (SBUX) and Popeye's (AFCE) were Q3 (and Q2) positive standouts: positive sales and traffic, sales beat and earnings beat $.01 or more over estimate. Does prior performance guarantee future results?

    Dividends as the goal: Dividends will be important in a low growth, low return world. The US restaurant market is way overdeveloped and worldwide development takes time and proper store level economics.

    We'll be glad to see companies like DNKN (1.80% yield), BKW (.90% yield), and BLMN (0%) finally work their way out of private equity positions so that more substantial dividends can be paid.

    THI, another pure play 100% "capital light" franchisor, is also low at 1.70%. That there are two coffee sector players in this group is interesting. Lower coffee commodity costs advantage will accrue to the franchisees not the corporate entities.

    IPOs and M&A Pending: we still wonder when Noodles will be ready for their IPO. Fast casual is "hot". Another fast casual brand, Pei Wei could be a candidate once its lower newer unit open sales problem is fixed.

    It was clear from the 2012 SBUX and DRI transactions that the path to a rich valuation is to develop a unique but mainstream product that well-heeled restaurant majors can buy for entry at rich multiples.

    There will continued private equity churn, they always have fresh powder to deploy. The wave of 2006-2008 PE acquisitions will soon come due to sell.

    Turnarounds to watch: Interesting that the two worldwide restaurant leaders, MCD and DRI are both challenged. No surprise that MCD went into a new news decline as it changed CEOs in 2012. When will it change?

    It will be fascinating to watch Darden (DRI) work out of its current tight cash position caused by lagging big brands and resulting profit shortfall, big remodeling CAPEX requirements and now debt service for its 2012 acquisitions. Of necessity, they will look for another acquisition in 2014, once its free cash flow position improves.

    We wonder if BKW has the worldwide AUV sales base potential except Latin America for franchisees to expand profitably.

    Restaurants must more creatively test revenue and expense solutions: Restaurants can offset negative cost pressure and difficult comps pressure by looking at revenue increases beyond price increases and cost reductions beyond food portion cuts and labor hour savings.

    Unique store level pricing tiers and dual wage tiers to offset Obamacare are but two examples. The industry needs to test aggressively new ideas. I've published more details on my website, pacificmanagementconsultinggroup.com.

    Defrancising v. Refranchising divergence will continue. Those who can operate restaurants well will continue to do so, those who can't, refranchise. Panera (PNRA), Texas Roadhouse (TXRH) and Qdoba (NASDAQ:JACK) are building new units /converting franchisees to company operation.

    Franchisors still need to improve investor reporting and franchisee disclosure if they hope the franchising "capital light" business model will be sustained. How can DineEquity (NYSE:DIN), now 100% franchised, be properly analyzed if there is no franchisee profitability reporting?

    Reasons for optimism: always. Commodity costs thus far are coming in at the light end of what was feared some months earlier. Some companies have finally fixed their marketing focus, example Sonic (NASDAQ:SONC). The revenue and cost challenges so often noted can be offset. And finally, this is a very adaptive industry. It just needs to get more creative.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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    This was very good overall perspective and thoughtful insights in the restaurant industry.
    12 Feb 2013, 03:05 PM Reply Like
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