Economy trims restaurant stocks

The Baltimore Sun

There's a special on restaurant stocks, with many down 50 percent or more in price because of the weak economy.

The restaurant industry certainly is never going away. But the question is whether it is too early to invest now, because many of these companies are struggling.

Industry concerns were dramatized by the closing of many Bennigan's and Steak & Ale restaurants after their owner, S&A; Restaurant Corp., filed for bankruptcy last month. Vicorp Restaurants Inc., operator of Village Inn and Bakers Square, filed for Chapter 11 in April, which lets it reorganize and remain open. Both firms are private.

"Americans have not stopped going out to eat and aren't going to stop, but they are being forced to decide," said Allan Hickok, managing director and head of the restaurant group for the Houlihan Lokey investment bank. "Their discretionary income pool is smaller, so if a restaurant isn't on their personal 'A' or 'B' list, they will drop it." Whenever they do opt to dine out rather than stay home, they are increasingly sticking with the basics and cutting back on appetizers, desserts and beverages, experts said.

Pin some blame for the fix that restaurants are in on the easy credit that encouraged them to borrow in order to expand. They committed the same mistakes that everyday consumers and other industries did in recent years.

"The restaurant industry is overstored, especially in casual dining, with demand nowhere near the increased supply of stores over the past five years," said Ron Paul, president of Technomic, a food industry research and consulting firm. "The companies could get the money, so they opened up the stores."

Although major chains won't go out of business, they are going to be closing stores, Paul said. It will be 12 to 18 months before demand catches up to supply in the restaurant business, he said.

"These stocks are very, very, very cheap because their fundamentals keep getting a little worse," said Bryan Elliott, senior restaurant analyst with Raymond James & Associates. "But if you have a time horizon of two or more years, at some point they're going to have a big, big recovery."

The economic downturn presents a significant challenge for restaurateurs: Of restaurant operators responding to a recent tracking survey of the National Restaurant Association, 29 percent identified the economy as their No. 1 challenge.

The problems are likely to last, although stocks could be in for a turnaround first, experts said.

"We could be close to a bottom for the restaurant stocks, though the businesses themselves will continue to have a tough time the rest of this year and into 2009," said John Owens, stock analyst with Morningstar Inc. "Yet a lot of the higher-quality companies with strong brands, balance sheets and management teams will survive and be well-positioned when the economy turns around."

The bottom line of restaurants of all types, including the high-end locations, is being hurt by the economy.

Fast-food chains are affected somewhat less than the others because families have been shifting to them from casual-dining restaurants. Rising commodity costs, the increase in the minimum wage and low-cost value meals are decreasing fast-food chains' profits, but they have also been attracting some new dinner and late-night customers.

"Many of the independent restaurants, which are locally owned and operated, have managed to do just fine in the current environment," said Hickok, the investment banker. "They aren't big and don't have a lot of marketing muscle, but they are able to compete with the things they can control, like service and commitment to customer satisfaction."

Within the restaurant industry, there are companies whose stock prices have been sliced by the overall economy but exhibit excellent survival and growth prospects. For patient investors, these offer opportunity.

Elliott recommends this menu of attractively priced shares:

* Brinker International Inc., parent company of Chili's, Macaroni Grill and Maggiano's.

* Texas Roadhouse Inc., a chain of nearly 300 steakhouse restaurants.

* California Pizza Kitchen.

* CBRL Group Inc., parent company of the Cracker Barrel restaurants.

* P.F. Chang's China Bistro Inc.

"Restaurant stocks can be pretty volatile and they continue to be out of favor," said Owens, who notes that a recent easing of oil prices was a significant help to the industry. "But those with strong brands and management have been through it all before and should weather this well."

Owens recommends:

* Yum Brands Inc., which owns KFC, Pizza Hut, Taco Bell, Long John Silver's and A&W; All-American Food Restaurants.

* Darden Restaurants Inc., parent company of Olive Garden and Red Lobster.

* Chipotle Mexican Grill Inc.

Finally, while Hickok doesn't make stock recommendations, he considers shares in the following smaller restaurant companies attractive and worth watching by potential investors:

* Buffalo Wild Wings Inc.

* BJ's Restaurants Inc.

* Granite City Food & Brewery Ltd.

Andrew Leckey writes for Tribune Media Services.

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