A few weeks ago, my Foolish colleague Ryan Fuhrmann commented on Landry's Restaurants' (NYSE:LNY) recent struggles in the casual-dining segment under its flagship Joe's Crab Shack brand. Its recent performance was so unappetizing that management is now considering plans to abandon casual dining altogether, focusing instead on higher-end offerings.
Since Ryan's article, Landry's released its second-quarter results. The situation at the restaurateur isn't beyond repair, but with same-store sales growth coming in at just 1% for the period, it's not exactly glowing, either. To get a better picture of management's perceptions of underperforming Joe's Crab Shack, and what's next for the struggling concept, I've asked Hank Schofield and Bodhi Zappa to join me in a roundtable discussion about the company's latest quarterly earnings conference call.
Not sold on the macroeconomics excuse
Jeremy: In the call, Landry's, Chart House, Rainforest Cafe, and Saltgrass were highlighted as areas of strength in Landry's Restaurants' second quarter. Not so Joe's Crab Shack. CEO Tilman Fertitta said that the casual-dining concept continues to "experience weaker sales patterns than anticipated." Hank, what's wrong with the seafood specialist?
Hank: If you want to buy management's reasoning that the struggles are due to macro-level concerns like rising interest rates and fuel increases, knock yourself out. I'm not sold. The logic simply doesn't equate when you consider that Saltgrass, its higher-end concept, is doing just fine. If the consumers are truly feeling the pinch, are they going to opt for a higher-ticket dining experience?
Jeremy: Fertitta indicated in the call that in the latter half of 2005, the company "conducted many tests in an attempt to improve food options and refined the experience for the Joe's customer." The majority of these tests failed. But the time and resources that management spent on such product developments suggests to me that economic issues aren't the sole factor, and that Landry's identified areas within its own operations in need of improvements.
New menu items: the winning ticket?
Bodhi: No worries, fellas -- management isn't throwing in the towel just yet. Fertitta added that the tests that proved successful are now "being tested in additional markets." One specific and favorably received change was something as simple as bread. Joe's diners used to be greeted by a basket of assorted crackers on their tables. During the Q&A portion of the call, CFO Rick Liem stated that now all "Joe's customers get bread when they come in."
In addition, Joe's will move away from television advertising to focus on direct mailing and local media -- outlets that allow the company to hit consumers with more frequent marketing messages. The new advertising campaign will be linked with its strategy to bring new menu items to the market on a monthly basis, in hopes of keeping consumers interested in the concept.
Hank: Bread? Management just now figured out that people like to munch on bread while waiting for the main entree?
Jeremy: Adding new menu items more frequently is a sound strategy. We've seen this successfully implemented by Sonic (NASDAQ:SONC), Ruby Tuesday (NYSE:RI), and Papa John's (NASDAQ:PZZA), to name just a few. If the company can pull this off, it should create a buzz among its loyal customers, which may in turn drive in new customers, increasing same-store traffic.
Joe's may get the boot
Hank: I'm still not sure Landry's can pull this off. (Again: bread?) For one thing, the company is actually cutting back on advertising costs -- precisely when it should be ramping up. One analyst asked if observers should expect to see sales decline, since the company will be spending less on marketing. Fertitta responded, "You are going to have a sales falloff."
Landry's efforts may be too little, too late. In July, the company retained the services of Wachovia Securities and North Point Advisors to "assist in evaluating strategic alternatives for Joe's Crab Shack." Tilman added that the move "will allow us to concentrate more on our higher-end restaurant concepts." Read between the lines -- that means Joe's may be on the outs.
Bodhi: Let's be fair, Hank. Tilman did add, "Advertising costs in television markets have gone up 10% to 15% in the last 18 to 24 months." This kind of cost increase doesn't mesh well with a casual dining segment struggling through a difficult economic environment.
And if Joe's is on the outs, so be it. I see this as a win-win for the company. It wins if it can ramp up sales through new menu items and a fresh marketing strategy, and it wins by selling off its existing Joe's units, using the proceeds to pay down debt and focus on the expansion of its Saltgrass concept.
Biting the bait?
Jeremy: The market may agree with Bodhi's win-win outlook. When the company initially announced plans to reevaluate its Joe's holdings a few weeks ago, shares for Landry's immediately shot up 8% in trading. A look at other restaurant chains suggests that bringing new menu items to market more frequently, coupled with a savvy advertising campaign, is a recipe for success. However, the other option seems to be the prevailing one right now: Sell off 120 of Landry's Joe's Crab Shack units, convert the other 22 into Saltgrass Steakhouses, spin off Saltgrass, and ultimately focus on the Golden Nugget concept.
But is it a win-win? I'm not so sure. One analyst in the call echoes my sentiment when questioning the timing of a Joe's sale, particularly when it's on the "downswing of profits." Tilman's response wasn't particularly comforting: "Could it be a bad decision? In one way, maybe it is; in another way, it isn't."
One thing is certain: Major changes are under way at Landry's. Should investors jump onboard or jump off? If the right choice isn't clear to you, watching Landry's from the sidelines may be the best option.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.
