Restaurant stocks looking more appetizing


Next helping, please.

At the opulent 1995 stock market feast, it's increasingly difficult to find value-priced stocks on the menu.

Many restaurant stocks, however, are bargains. Their considerable earnings potential is being overlooked because they've lately given investors nothing but indigestion.

A large number of restaurant companies went public in 1991 and 1992, with impressive industry earnings growth continuing through 1993. But earnings slowed considerably last year when consumers encountered a difficult economy as the Federal Reserve raised interest rates repeatedly to ward off inflation. Dining out suffered.

The most aggressive fast-food restaurants, in particular McDonald's Corp. and Wendy's International, stayed strong with a skillful emphasis on efficiency, value and marketing. Lesser competitors didn't fare as well.

Full-service casual dining in particular stumbled as consumers encountered a "restaurant row" of similar establishments with similarly priced food. Competition is stiff. Nonetheless, this group should hold long-term benefits for patient stock investors as less capable chains fall by the wayside and successful ones expand.

"In full-service casual dining, only 15 percent of food consumed is done by the chains and the rest by independents, but chains will gain significant market share over time," predicted Roger Lipton, president of the Lipton Financial Service Inc. consulting firm.

For example, chains controlled just 15 percent of the fast-food industry 30 years ago but today have 85 percent, and independents have been squeezed out.

"A miserable 1994 and difficult 1995 for restaurant stocks created an investment opportunity, though you must have an investment time horizon of 18 months," said Joseph Buckley, managing director of Bear, Stearns & Co.

That wait is necessary because some positive trends are on the wane. In the early part of an economic recovery, people eat out more and restaurant sales growth is pronounced, Mr. Buckley noted. You don't enjoy that benefit when you get this deep into the cycle.

"Women entering the work force and Americans staying single longer dramatically increased the number of people eating out, but both trends have reached a steady state," added Harry Venezia, analyst with Raymond James & Associates.

This industry is tracked intensively.

"Restaurant stocks look interesting for value investors," advised Caroline Levy, senior vice president with Lehman Brothers. "But remember, these stocks can move significantly up or down on a given day because of the microscopic focus that's being placed on same-store sales figures."

McDonald's stock is admired by Mr. Buckley, Ms. Levy and Mr. Lipton. With more than 15,000 restaurants worldwide and an additional 1,500 traditional units and 1,000 satellite units being added each year, the firm is an aggressive industry leader. Its "value menu," begun 4 1/2 years ago, has had dramatic impact on sales and profitability.

It's now a worldwide brand, with more than half its earnings from overseas. Its critical mass of restaurants is expanding beyond six primary countries and there's been a positive kick from the decline of the U.S. dollar. International remains the growth vehicle, with 20 percent to 25 percent annual earnings gains vs. mid-single-digit in the United States. That all adds up to a growth of 15 percent to 16 percent annual earnings per share.

Wendy's is a favorite of Ms. Levy and Mr. Lipton because theconsider it the cream of the crop in the domestic fast-food business. Popular spokesman Dave Thomas provides a marketing boost. With just 4,000 stores, Wendy's has tremendous room for growth. It's a value play because it has had 20 percent or better annual earnings growth the past five years, yet its stock price doesn't reflect that.

Morrison Restaurants, with its Ruby Tuesday, Mozzarella's and Tia's casual dining restaurants, food services and cafeterias, is a Buckley selection. It restructured into a 20 percent growth story, yet its stock is selling at a substantial discount. The firm's casual dining unit should have 25 percent long-term annual earnings growth.

Outback Steakhouse, its steak restaurants growing at a 30 percent annual clip and its Carraba's Italian Grill offering potential, is favored by Mr. Venezia and Mr. Lipton.

Other Venezia picks are Apple South, largest operator of Applebee's restaurants and owner of Tomato Rumba's Pastaria Grill; DF&R; Restaurants, which operates Don Pablo's casual dining Mexican restaurants; and Lone Star Steakhouse, an internationally expanding chain that cuts steaks in-house and displays the fresh meat.

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