The past few quarters have been tough on shareholders of casual dining chains such as Darden International's (NYSE:DRI) Red Lobster and Olive Garden franchises, Bravo Brio Restaurant (NASDAQ:BBRG), and BJ's Restaurants (NASDAQ:BJRI). While the stock market and the economy have improved, these restaurants have stalled mightily.
The big question is whether these restaurants are going through a brief dry spell, or are they suffering a permanent trend downward? There's a few different ways to look at the problem.
Stuck in the middle
The past few quarters have been good for restaurants in fine dining, quick service, and especially fast casual (the sector grew 12% year over year). The one area that is struggling is casual dining.
The numbers back this up. Just look at Darden Restaurants closely. Casual brands like Red Lobster and Olive Garden recently had comparable sales declines, of 4.5% and 0.6% respectively. Yet, the rest of their brands, including the up-scale Capital Grille, have done very well, prompting investors to push for a casual "spin-off" of Red Lobster.
Securities Analyst Andy Barish, of Jefferies Equity Research, recently predicted an oversupply of casual dining restaurant locations continuing in 2014. In short more consumers are opting for either cheaper (fast casual), or more expensive (fine dining), options which don't bode well for casual dining. This segment just seems to be stuck in the middle.
The most recent quarter for Bravo Brio was rougher than Olive Garden's, as comparable sales declined 4.5%, and EPS dropped by over 20%. The problem isn't limited to Italian food, BJ's third quarter also saw a comparable sales drop of 2.2%, and earnings are set to decline more than 20% year over year.
These businesses are losing market share to fast-casual. They're not offering a compelling enough value proposition, and they have expenses and capital expenditures (additional staff, equipment, long menus) that fast-casual chains do not have.
Is the economy to blame?
I recently wrote that Ruby Tuesday's CEO J.J. Buettgen made a ridiculous statement, by blaming the economy for poor results, because GDP and restaurant industry traffic are at twelve month highs. To his (slight) credit though, recent studies have shown that increases in U.S. consumer discretionary spending have favored the wealthiest Americans.
If this trend continues, we could see casual dining in the dumps for a while. Let's face it, affluent Americans aren't usually going out to dinner at BJ's or Red Lobster. No, these are the restaurants that middle class folks go to, when they're feeling a bit better about their personal finances. If they're feeling tight, they may opt for Panera and skip paying a tip. Meanwhile, the rise in discretionary spending for the wealthy explains some of the stabilization in higher-end dining.
If this trend continues, it could be a lag on casual dining for a few quarters. It's a part of the puzzle, but not an excuse on its own.
Casual dining chains need to reconnect with customers
In my opinion, the biggest reason these chains are struggling is that they are missing what customers are looking for right now. In the aforementioned report from Jeffries, the Analyst noted that there "would still be ample opportunities for innovative brands to take market share in the new year." And while casual dining has cooled, chains that serve products customers want, like Buffalo Wild Wings, have flourished with similar cost structures.
The National Restaurant Association's recently released its trends for 2014 , which include locally grown produce, and a focus on natural ingredients. This could be an area that these restaurants, especially the Italian chains, could try to adapt to. If either restaurant chain can serve food that seems fresh, vibrant, and more natural, they may be able to justify their higher price tags.
At the very least menu and brand innovation is needed. I don't think Olive Garden's new burger will be enough to move the needle, but if you own shares of these chains you should watch for real innovation.
Something needs to change, preferably in the menus, to reengage customers.
Foolish conclusion: focus on trends
To quote a recent post by fellow Fool Jason Moser, "you go to Chipotle because you know what you want; you go to Buffalo Wild Wings because you know what you want." So, do people only eat at Darden's restauarants, BJ's, and Bravo Brio, when they can't decide what they want?
The customer is gravitating to higher-end, and lower-end, options. If these restaurants want to compete, they'll need to offer something compelling to off-set this competitive drag. It starts with menu innovation, focusing on trends, and reengaging the customer.
They need to offer a compelling reason to eat at their restaurants, until they do, they're an endangered species.
Adem Tahiri owns shares of Bravo Brio Restaurant Group. The Motley Fool recommends BJ's Restaurants. The Motley Fool owns shares of BJ's Restaurants and Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.