Restaurant Resurgence (Stock Research) May 25, 2000

Research Restaurant Resurgence

With Rick Munarriz (TMF Edible)
May 25, 2000

Putting your money where your mouth is has proven to be an unrewarding exercise in recent years. Since the casual steakhouse boom of the early 1990s rode off into the sunset, restaurant stocks have underperformed the market year in and year out.

The reasons are simple. Technology and new economy companies captured the imagination of investors seeking high-octane growth opportunities. In the restaurant industry, consumer expansion is limited by incremental same-store-sales growth and the ability to build out a chain. It's an easy science but it tosses any notion of triple-digit sales growth out the drive-through window.

The sector, which relies on the pimply faced youth of America to don aprons and broomsticks, has also been susceptible to the current double whammy of minimum-wage hikes and a tight labor market.

Ultimately, it all becomes a self-fulfilling prophecy. Capital funding has been limited as investors are weary that the next hot concept might wind up being the next Boston Chicken or Planet Hollywood -- both former high fliers that spent the bulk of last year in bankruptcy proceedings.

The lack of company-owned expansion, along with lingering apathy from franchisees to carry out the grunt work, means eateries are riding the brake pedal. That is why Technomic reports that just 16 chains had system-wide sales growth of 20% or better last year. The top dog, CBRL's (Nasdaq: CBRL) Logan's Roadhouse, had top-line growth of 41%. Fittingly enough for the sector's malaise, CBRL stock was off 58% last year.

Are times a-changing? Could be. For starters, shares of CBRL (which is better known for its flagship Cracker Barrel Old Country Store roadside restaurants) have risen 39% year-to-date.

Value in the shares of Avado Brands (Nasdaq: AVDO) and Rainforest Cafe (Nasdaq: RAIN) inspired management-led buyout attempts. Both were discarded earlier this year when institutional investors and concerned shareholders cried foul (or should that be "fowl"?).

There is new life in this discarded sector. Granted, bellwether McDonald's (NYSE: MCD) is trading unchanged this year. With 27,000 locations -- serving 40 million hungry patrons every single day -- it is the indisputable market leader. The company is a cash machine, having generated $1.1 billion in free cash flow last year. But as can be expected, expansion is now geared more toward the overseas market where there is still prime real estate to be had.

More attractive possibilities have stemmed from those companies with plenty of domestic acreage left to conquer. Hot high-volume concepts like Cheesecake Factory (Nasdaq: CAKE) and P.F. Chang's (Nasdaq: PFCB) have found their shares more than doubling over the past year.

Unlike their fallen brethren of fads past, these casual dining specialists are doing more than attracting huge crowds with every new location -- they are maintaining the traffic. Cheesecake Factory has reported higher same-store sales for 31 consecutive quarters. At Chang's, comps rose an amazing 15% for the first quarter.

The market has been ripe for the successful upstarts who now find few worthy competitors dotting the landscape. But even the heavyweights, Big Mac notwithstanding, are beginning to sizzle.

Outback Steakhouse (Nasdaq: OSSI), a stock for further study in our Industry Focus 2000 report, has been a bit of a Bloomin' Onion this year -- up 19% while the S&P is off 6% and the Nasdaq Composite has shed 22% through Tuesday.

Brinker International (NYSE: EAT) has been faring even better. The parent of Chili's and Romano's Macaroni Grill has seen its shares climb 34% this year. While other major players like Wendy's (NYSE: WEN) and Darden (NYSE: DRI) are showing just marginal capital appreciation year-to-date, that is still a big win relative to the market as a whole -- and that is something restaurant stocks haven't been able to claim in years.

Yet despite the recent attention many eateries are trading at bargain prices. Applebee's (Nasdaq: APPB) is fetching just 14 times this year's projected earnings. Profits for the company with the most casual dining units are slated to climb 19% this year and 15% next year. Outback and Brinker are also going for P/E multiples in the teens.

That's right, teens. As in the young faces working the counter at the Mickey D's down the street. The ones that say "Can I help you?" But you can help yourself this time -- the menu of restaurant stocks sounds so appetizing and the Value Meal pricing is too good a deal to pass up. Or drive-through.