According to the National Restaurant Association, 2017 is set to be the eighth consecutive year of real sales growth in the restaurant industry. Notably, the industry’s sales account for 4% of the U.S. GDP. Amid all the talks of restaurant recession, strong sales and digital initiatives undertaken by restaurateurs to counter comps and traffic issues along with improving economic indicators in the U.S. should bring some relief.
Taking the past trends and long-term growth prospects of the industry into account, we highlight a few positives of investing in the restaurant space:
Various Sales Building Strategies: In order to navigate a challenging sales environment, restaurant operators are continually striving to innovate on the menu front to cater to the ever-changing palates of customers and entice them once again. Some of the notable restaurateurs playing this card are Chipotle Mexican Grill, Inc. CMG, Buffalo Wild Wings Inc. BWLD, The Wendy's Company (WEN - Free Report) and Jack in the Box Inc. (JACK - Free Report) .
Another initiative undertaken by the food chains is re-imaging of stores, which has received overwhelming response from guests. Wendy's, Domino's Pizza, Inc. DPZ, Brinker International, Inc. EAT, Ruby Tuesday, Inc. RT and Red Robin Gourmet Burgers Inc. (RRGB - Free Report) have been working on these lines. Notably, reimaging of stores helps to create an appealing and differentiated concept that helps to boost the brand as well as improve client experience.
Meanwhile, restaurant companies like BJ's Restaurants, Inc. BJRI, Buffalo Wild Wings, Brinker International, Red Robin, Starbucks Corp. (SBUX - Free Report) and Dunkin' Brands Group, Inc. DNKN offer loyalty programs at their outlets to enhance value dining. The companies engage its guests through these programs with offers designed to increase frequency of visits. Loyalty programs thus help retain old diners while bringing in new ones, thereby driving traffic.
On the other hand, industry players like Buffalo Wild Wings,Brinker and BJ's Restaurants are rolling out prototypes and smaller restaurant chains to augment value and drive traffic. This in turn will lower construction and occupancy costs but boost return on invested capital. Notably, smaller prototypes also accelerate growth in non-traditional locations.
Increased Focus on Modern Technology, Digital Ordering: The digital wave has hit the U.S. restaurant space as an increasing number of restaurateurs are deploying technology to enhance guest experience. The companies’ online and digital marketing activities have thus increased significantly over the past several years in response to increasing use of online and mobile web technology.
While smartphone apps attract consumers, video menu boards in quick-service restaurants and tabletop devices speed up sales and ensure convenience. Further, restaurant operators rely on social media for promotions and incorporate Facebook, Inc. (FB - Free Report) , online review sites, Twitter, Inc. (TWTR - Free Report) and blogs aggressively into their marketing mix.
Domino's continues to add to its digital capabilities with the launch of various ordering apps and platforms which should boost digital orders. The extended ways to order a pizza has in fact kept Domino’s in the forefront of digital ordering and customer convenience. Papa John's International Inc. (PZZA - Free Report) too aims to continue investing in technology focused on foundational improvements to its digital channels to increase order conversion rate, frequency and ticket average.
Additionally, the world’s largest coffee shop operator, Starbucks Corporation (SBUX - Free Report) has secured a leading position in leveraging its mobile and digital assets and loyalty and e-Commerce platforms to create more revenue streams. Dunkin' Brands Group, Inc. DNKN is also growing in terms of its usage of digital technology through DD card, DD mobile app, DD Perks rewards program and On-the-Go ordering. While BJ's Restaurants has completed the roll-out of new server hand-held ordering tablets at all its restaurants, Brinker is also testing handheld devices in order to increase efficiency and speed.
Meanwhile, Chipotle is moving aggressively to make digital ordering more appealing to its customers in order to drive digital sales and lure customers. In this regard, it recently completed the rollout of its “Smarter Pickup Times” technology at all its restaurants that offer digital ordering.
McDonald's Corp. (MCD - Free Report) has also finally begun testing mobile order-and-pay capabilities on its app in the U.S. and is set to launch the optionin nearly all 14,000 U.S. restaurants and 6,000 of its restaurants in the U.K., Canada, France, Germany, Australia and China, by the end of this year. Having witnessed continual traffic declines, the company considers mobile ordering a way to win back customers.
Delivery Gain Precedence: Furthermore, in order to capitalize on increasing demand for their products, quite a few players in the industry are focusing on growing their off-premise, online-ordering business via carry-out, delivery and catering.
Particularly, restaurant operators are increasingly focusing on the delivery channel, which is a growing area for the industry driven by ease of access. By driving incremental sales at the companies, delivery services should turn out to be a strong revenue growth driver in the long term, given huge demand for the same.
Starbucks has initiated a food and beverage delivery service while Yum! Brands is pursuing delivery-centric strategy at all its brands. Meanwhile, fan following has been extremely positive and Buffalo Wild Wings thus aims to aggressively pursue third-party delivery to more restaurants throughout 2017. The Cheesecake Factory Inc. CAKE has also rolled out the service in nearly half of its restaurants with plans in place to continue introducing delivery to additional locations in 2017 as it is leading to incremental sales. In fact, to provide augmented convenience to customers, McDonald’s is increasingly focusing on delivery.
Notably, the likes of BJ’s Restaurants, Dunkin' Brands, Jack in the Box, Red Robin and Wendy's have entered into partnership with DoorDash -- which connects customers with their favorite local and national businesses in more than 500 cities across the U.S. and Canada through door-to-door delivery -- to meet the delivery needs of their new and existing guests and cash in on its tremendously growing popularity.
International Expansion: A number of restaurateurs are committed to expedite their presence in high-growth international markets to boost their business. Pizza Chains Domino’s and Papa John’s are leading the race for international expansion.
Notably, Domino’s earns a chunk of its revenues from outside the U.S. with many international franchisees continuing to generate robust returns. In fact, the second quarter of 2017 marked the 94th consecutive quarter of positive same-store sales in its international business. Many of Papa John’s restaurants are also located in international markets like United Kingdom, Mexico and China. The second quarter of 2017 marked the 30th consecutive quarter of positive comps in the international segment.
Meanwhile, Cheesecake Factory continues to foray into lucrative markets like the Middle East, North Africa, Central and Eastern Europe, Russia, Turkey, Mexico, China, Kuwait and Lebanon and Chile. Also, Brinker is one of the few fast casual restaurant chains that have been expanding despite sluggish economic development.
Management is gearing up for international expansion, especially in the faster growing emerging markets. Restaurant Brands International, Inc. (QSR - Free Report) believes that there is an attractive opportunity to grow all its brands around the world by expanding its presence in existing markets as well as entering new markets.
Cost-Cutting Effort & Shift to Franchise-Based Business Model: Given the exponential rise in costs, companies are striving to keep expenses under control. Notably, various measures to keep costs under control coupled with ongoing commodity cost deflation are helping Cracker Barrel make solid progress in its cost-reduction targets.
Additionally, these initiatives are also expected to aid the company in combating some of the wage inflation pressures. Darden Restaurants, Inc. DRI is also focusing on an aggressive cost management plan, under which it has been able to significantly cut operating costs.
Of late, various companies in the restaurants space like Yum! Brands, Inc. (YUM - Free Report) , Restaurant Brands, McDonald’s, Domino's, Wendy's, Papa John's and Jack in the Box have adopted a de-risking strategy by reducing their ownership of restaurants through refranchising. Notably, refranchising a large portion of the system reduces the company’s capital requirements and facilitates earnings per share growth and ROE expansion.
In addition, free cash flow continues to grow, thus allowing reinvestment for increasing brand recognition and shareholder return. Moreover, since a major portion of their business is re-franchised, these companies are less affected by food inflation than their peers.
Adapting to Changing Consumer Preference: U.S. eateries’ focus on serving customers a healthy menu has increased manifold as consumers are increasingly showing their preference for fresh, organic, nutritious and low-calorie food.
Recently, Chipotle fulfilled its pledge of not using added colors, flavors or preservatives of any kind in any of its ingredients. In fact, the company’s deeper focus on making better food accessible to everyone should also aid in bringing back health-conscious customers. Papa John’s is also committed to provide quality food and serve better ingredients to its customers.
McDonald's has discontinued the use of chicken raised with antibiotics, started using real butter, not margarine in breakfast sandwiches, and has removed the high-fructose corn syrup from buns. The company is also set to discard the use of frozen patties in favor of fresh beef in all its popular “Quarter Pounder” burgers across the majority of its U.S. restaurants by mid-2018. Yum! Brands’ KFC has also pledged to discard the use of chicken raised with antibiotics – commonly used to treat humans – at more than 4,000 of its restaurants in the U.S., by the end of 2018.
Meanwhile, companies like McDonalds, Dunkin' Brands, Wendy's and Panera Bread are shifting to cage-free eggs to appease health-conscious guests.
Moving to the consumer side, it seems that Americans are keener on having breakfast at restaurants as exclusive breakfast offerings have been driving traffic at most U.S. restaurants, outpacing conventional lunch and dinner items. The breakfast segment is also gaining popularity because of lower rates than other meals and lesser waiting time. In fact, the consumption of breakfasts and morning snacks, in and away from home, is projected to grow 5% through 2019, according to research firm NPD Group.
Fast food giant, McDonald's started its own all-day breakfast platform in the U.S., which has proven to be a remarkable success. In fact, Denny's Corporation DENN and Jack in the Box have been offering all-day breakfast for quite some time now, highlighting how the trend has been successfully driving sales. Dunkin' Brands also sells breakfast sandwiches all day, which is a major contributor to sales.
Other players in the industry like Yum! Brands’Taco Bell is also capitalizing on rising demand for breakfast. With breakfast foods playing a key role in the daily eating habits of restaurant-goers, the fast food industry has been able to turn around and drive growth even as non-healthy items in their menus are falling out of favor.
Favorable Macro Factors: A gradually improving U.S. economy given solid employment picture, rising wages, higher real income and increased household net worth has reinforced consumer confidence and sentiment. In fact, the Consumer Confidence Index climbed from June’s reading of 117.3 to 121.1 in July.
We anticipate this positive sentiment to encourage consumers to dine out more and thereby somewhat put a check on declining traffic. Moreover, it is to be noted that eating out is one of the items in the family budget that has grown many folds as households get a boost. This bodes well for the restaurant sector and should aid in keeping investors’ appetite high for restaurants in 2017.
Stocks That Warrant a Look
A couple of restaurant stocks we are bullish on include Domino’s and Del Taco Restaurants, Inc. (TACO - Free Report) holding a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Despite being Zacks Ranked #3 (Hold) stocks, we also find McDonalds’s, Darden, Yum! brands, Wendy’s and Dave & Buster's Entertainment, Inc. (PLAY - Free Report) worth considering given the momentum in their underlying businesses.
There are plenty of reasons to be optimistic about the restaurant industry’s near- to medium-term outlook. Effective sales and digital initiatives undertaken by the restaurant companies, particularly enhanced focus on mobile ordering and delivery, to cater to ever-changing wants and needs of customers are likely to aid them in defying industry-wide headwinds.
We thus expect the industry to grow at a modest pace. Predominantly, innovative operators with strong fundamentals are likely to continue exhibiting strength even in a not-so-favorable environment. Hence, investing in some sound restaurant companies to satisfy your appetite should not be a bad proposition.
Check out our latest “Restaurant Industry Outlook” here for more on the current state of affairs from an earnings perspective and the trend for this important sector.
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