Will Restaurant Stocks Crumble Under Shutdown Pressure?

The broader market reacted to the government shutdown with something of a yawn. On the day itself, indexes were up comfortably. So far, it seems that most investors are not particularly worried, and the market is telling us it has confidence in a timely resolution. The restaurant industry has been taking it on the chin though, as concerns over the shutdown bogging down an already sluggish consumer spending climate had investors worried. Is the sell-off justified?

During the shutdown, 700,000 federal employees will be on unpaid leave, as US government services deemed non-essential are put on hold. Institutions like the Smithsonian, Library of Congress and National Parks are all affected, as well as the Departments of Education, Energy, and Health and Human Services. As for the exceptions, the US postal service will continue chugging along, as will the Department of Defense. According to Goldman Sachs, a three-week shutdown could affect US GDP by as much as 0.9% this quarter . So far, the process seems all but deadlocked, with neither side willing to compromise .


Commentators are particularly concerned with the effect of the shutdown on consumer spending.  As such, industries heavily reliant on this environment have been reacting especially harshly to the shutdown. On Wednesday, restaurant stocks were down across the board with Wendy's (NASDAQ: WEN  ) leading the decline, down 2.3%. Among others, this was followed by Yum! Brands (NYSE: YUM  ) down 1.7%, Brinker International (NYSE: EAT  ) with a 1.3% decline and Darden Restaurants (NYSE: DRI  ) with a 0.6% decline.

What's in your wallet?
Making matters worse is that restaurant traffic was already under pressure, although things appear to be turning around a bit as of the second quarter. For the period, quick-service restaurants saw traffic increase by 1%, while casual dining traffic was flat . Wendy's, now home to a curious looking product called the "Pretzel Bacon Cheeseburger," didn't manage to capitalize as well as it could have on this increased traffic, with same-store sales up only 0.4%, but earnings per share beating by $0.02 . These mixed results and the company's sluggish sales growth led to a downgrade at Zack's, cut to neutral from outperform, no doubt exacerbating the sell-off.

Also on review for a downgrade is Darden Restaurants, with Moody's citing weak earnings growth and stiff competition. Indeed, the company has missed analyst expectations for two quarters in a row now, with first quarter earnings per share dropping to $0.53 from $0.85 for a stiff decline of nearly 40%. Recent acquisition Yard House posted a 1.5% drop in same-store sales, while flagship brand Olive Garden posted a 4% decline. To combat the earnings decline, the company announced a number of cost-cutting measures including job and spending program cuts .

More bad news
The bad news also keeps pouring in for Yum! Brands. After a report stating China's KFC restaurants served chicken with dangerously high levels of hormones and antibiotics , the company was then hit by news surrounding the dubious (at best) quality of meat used for lamb hotpots across China.

As Yum! recently took over one of these chains, investors and consumers alike were concerned . Without going into the gory details, it was shown that the meat served in many of these dishes was far from lamb. To make matters worse, the company's most recent earnings report showed an 11% decline in China same-store sales, partly as a result of controversy surrounding the quality of its meat. The news sent the stock down 7% .

Brinker seems to be faring a little better than the rest of the pack with fourth quarter EPS beating expectations and rising 26% from the year-earlier period. The owner of Chili's Grill & Bar and Maggiano's Little Italy chains is posting some fairly decent comp store sales increases, with analysts expecting a 22% increase in earnings for the year. The company's outlook is fairly upbeat considering the spending environment. Brinker expects comp store sales to increase by 1-2% for the fiscal year .

Check, please!
Restaurant stocks have been taking a beating, as concerns over the government shutdown pressured consumer-sensitive companies. Yet, the underlying fundamentals for some of the companies mentioned here may have contributed to the drop, as they aren't stellar. Still, parts of the industry look fairly well positioned, with traffic on the uptick again, and the sell-off thus seems overdone for these names. Brinker looks like a particularly good bet in the restaurant world.

Now, for an extra tip....
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