Casual eateries are juicy targets

The Baltimore Sun

The economy has been unkind to restaurants this year, especially those that are stuck in the middle.

Fast-food chains with menus designed to help pinched family budgets have done fairly well. So have elite restaurants catering to high rollers undeterred by the size of their tabs.

But the dining segment between those ends is suffering through its most trying period in years.

This downturn provides an opportunity for investors to nibble at unexpected stock values. It is also a chance for restaurant firms to gobble each other up, sometimes rewarding shareholders in the process. There has been a string of restaurant deals this year.

Most recently, Darden Restaurants Inc., owner of Olive Garden and Red Lobster, announced an all-cash deal to buy Rare Hospitality International Inc. The latter has 287 LongHorn Steakhouse and 28 Capital Grille restaurants.

More maneuvering: Brinker International Inc., owner of Chili's and other restaurants, is talking to potential investors about selling its Romano's Macaroni Grill chain.

"Quick-serve restaurants and fine-dining restaurants have done pretty well, while casual dining has done pretty poorly," said Mark Sheridan, senior restaurant analyst with Johnson Rice & Co. in New Orleans. "I never discourage investors from following Peter Lynch's advice from the 1980s to buy what you know and buy what you like, but I'd also encourage them to read the company's finances carefully."

Before investing in any restaurant stock, determine whether its concept is in its early, middle or late innings, Sheridan said. That is because where it is in that cycle determines its growth potential.

"Restaurant companies have seen consumers pressured by gas prices ... and by resetting of adjustable-rate mortgages," said Greg Ruedy, research analyst with Stephens Inc. in Little Rock, Ark. "The companies are also being hit by cost pressures at the other end of their business from a higher minimum wage and higher commodity prices."

Shares of some of the outstanding restaurants in the casual dining segment have become expensive.

"Chipotle Mexican Grill is one of my favorite restaurants, and I eat there at lunch at least once a week," said John Owens, stock analyst with Morningstar Inc. in Chicago. "But even though it's an incredible business with huge growth prospects, I think its stock is overvalued."

Two popular restaurant stocks often mentioned as worthy of investment are P.F. Chang's China Bistro Inc. and Cheesecake Factory Inc.

P.F. Chang's, whose Chinese cuisine in a contemporary setting has a leading position in the rapidly growing Asian dining market, is a recommendation of Owens, Ruedy and Sheridan because its stock price is at a reasonable level.

The chain has a good primary business of 153 bistros developing nicely and the compatible 117-unit Pei Wei Asian Diner in the fast casual market. Taneko Japanese Tavern is a third concept in operation in Scottsdale, Ariz.

The core bistro business has been adversely affected by the tough economy, particularly in California, Arizona, Colorado and Nevada. The company lowered its full-year earnings forecast, and this pause creates an opportunity to buy a good company's stock at a value price, the analysts said.

Cheesecake Factory, with 127 upscale casual dining restaurants bearing its name and nine higher-end Grand Lux Cafes, is a Ruedy stock suggestion, while Owens would recommend it only after some price slippage.

Last year, the firm's two restaurant businesses were standouts in profitability, with Cheesecake Factory averaging $10.6 million in sales per restaurant and Grand Lux $12.6 million, Owens said. It also has two bakery facilities that produce desserts for other food-service operators, retailers and distributors.

Cheesecake Factory is the "best of breed" whose ability to execute a 200-item menu is "far and away superior" to competitors, Ruedy said. One problem is that its restaurants are usually so full at peak hours that it is difficult to increase same-store sales.

Cheesecake Factory will open its Asian test concept, Rock Sugar Pan Asian Kitchen, this year in Los Angeles.

There are plenty of restaurant stocks whose prices have become reasonable in the industry downturn. For example, Ruedy also recommends Benihana Inc.; BJ's Restaurants Inc.; Chuck E. Cheese owner CEC Entertainment Inc.; and Sonic Corp.

Morningstar "buy" recommendations include Ruth's Chris Steakhouse; Yum Brands Inc., owner of KFC, Pizza Hut and Taco Bell; Brinker; Panera Bread Co.; and Starbucks Corp.

Owens said Brinker, Panera and Sonic are strongly branded firms with good potential to be taken over.

"Clearly, some of the private-equity money in mergers and acquisitions has dried up, but there are a lot of other ways to finance acquisitions of restaurant companies," Owens said.

"There is sale and leaseback financing and selling off noncore brands, for example, and we expect there will be further activity, given that some of these restaurant stocks are pretty cheap."

Andrew Leckey is a Tribune Media Services columnist.

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