Restaurant Sector: Cooking Up Tasty Profits

by: Todd Campbell

Restaurants have captured headlines this past week as McDonald's (NYSE:MCD) continues to produce outstanding same store sales growth and Buffalo Wild Wings (BWLD) guidance sparked a flurry of short covering. But, can investors still buy the group?

Restaurant foot traffic dropped throughout the recession as consumers opted for brown bags instead of pleather booths. The industry got squeezed as emerging markets demand gobbled up excess grains, driving commodity costs higher. As a result, restaurants had to reinvent themselves. No longer could they rely on a steady stream of hungry shoppers eager for aspirational menus.

The menu renovations and a savage approach to cost cutting helped many operators boost earnings despite sluggish sales. Companies including Brinker International (NYSE:EAT) and Darden Restaurants (NYSE:DRI) saw earnings creep higher in 2010, despite ongoing headwinds tied to the sluggish post-recession recovery.

For the most successful operators, profits grew more markedly. While Darden's earnings rose 5.8% in 2010 from 2009, Chipotle Mexican Grill (NYSE:CMG) saw earnings soar 42.7%. Buffalo, Cracker Barrel (NASDAQ:CBRL) and Brinker all saw earnings climb 20% or more.

The earnings recovery provided companies with an opportunity to leverage leaner organizations for expansion. Real estate became cheap. Lease rates fell. And construction supplies and labor became increasingly profit friendly. As the economy improved further in 2011, companies found themselves in an enviable position of growing square footage and leveraging revamped operations as foot traffic and comparable sales picked up.

As we move into 2012, the same store, foot traffic and store count growth story remains front and center. In the most recently updated restaurant performance index, conducted by the National Restaurant Association, same store sales and traffic growth pushed the measure to its highest in just about six years. The reading logged its third expansion reading in the past four months as the same store sales component came in at its highest since 2004.

This is good news for investors. Particularly as income, consumer confidence and consumer credit improve. Healthier consumer balance sheets have made us more willing to spend again. And, a pickup in business travel supports restaurant revenue too. This helped Panera (NASDAQ:PNRA), Chipotle and YUM Brands (NYSE:YUM) post 15% or better revenue growth in Q4.

The sales growth should support better than hoped earnings this year. As consumers return to restaurants, food input costs have become less of a concern. Broiler and grain prices have stabilized and operators are better positioned to adjust to price changes. Analysts are paying attention, across all the stocks mentioned in this article, FY2013 earnings are expected to climb nearly 16% on average, with Cracker Barrel the lowest at 9%.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PNRA over the next 72 hours.