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Industry Outlook

According to the National Restaurant Association, 2016 could well be the seventh consecutive year of real sales growth in the restaurant industry. Notably, the industry’s sales account for 4% of the U.S. GDP. Meanwhile, restaurateurs expect to counter comps and traffic issues with strong sales, digital initiatives and by adapting to shifting consumer preferences.

Taking the past trends and growth prospects of the industry into account, we highlight a few positives of investing in the restaurant space:

Improving U.S. Economy: An improving U.S. economy and employment picture, along with rising consumer confidence, has contributed to slow but steady recovery in the restaurant industry. Though the decline in oil prices raised concerns of a global deflation and an economic slowdown, it is in fact driving consumer spending, which accounts for over two-thirds of U.S. economic growth. Thus, stepped-up economic activities, improving business conditions, renewed optimism as a result of housing recovery and mounting consumer confidence are expected to keep investors’ confidence high in the rest of 2016.

Various Sales Building Strategies: Endeavors to augment sales by targeting higher footfall and improvising on the menu are reaping benefits. Having stabilized their financial positions, restaurant operators are continually striving to add new items to their menu in order to cater to the ever-changing palates of customers while enhancing food presentation. Some of the notable restaurateurs here are Buffalo Wild Wings Inc. BWLD, The Wendy's Company (WEN - Free Report) , Papa John's International Inc. (PZZA - 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. and Carrols Restaurant Group, Inc. (TAST - Free Report) have been working on these lines. Notably, reimaging of stores helps to create an appealing and differentiated concept that helps the brand connect better with guests, especially millennials.

Meanwhile, restaurant companies like BJ's Restaurants, Inc. BJRI, Brinker International,Red Robin Gourmet Burgers Inc. (RRGB - Free Report) , Panera Bread Co. (PNRA - Free Report) and more recently Chipotle Mexican Grill, Inc. CMG have started offering loyalty programs at their outlets to enhance value dining. Loyalty programs help retain old diners while bringing in new ones, which drives traffic.

On the other hand, industry players like Brinker International, BJ's Restaurants and Red Robin Gourmet are rolling out prototypes and smaller restaurant chains to augment value and drive traffic, which in turn lowers construction and occupancy costs but boosts return on invested capital. Notably, smaller prototypes also accelerate growth in non-traditional locations.

Modern Technology, Digital Ordering & Delivery Gain Precedence: The digital wave has hit the U.S. fast casual restaurant sector as an increasing number of restaurateurs are deploying technology to enhance guest experience. 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, online review sites, Twitter, Inc. (TWTR - Free Report) and blogs aggressively into their marketing mix.

Notably, Panera Bread and Buffalo Wild Wings are employing tablet ordering and payment to drive traffic. Meanwhile, Red Robin Gourmet and Brinker International have partnered with Ziosk, a provider of ordering, entertainment and pay-at-the-table tablet, for the installation of tabletop technology at their outlets.

On the other hand, Chipotle is prioritizing its e-Commerce program and has entered into a partnership with Tapingo, a leading mobile commerce app that will provide food pickup and delivery services to students. The partnership will thus expand Chipotle’s existing delivery program in partnership with on-demand delivery service, Postmates.

Meanwhile, Papa John's has added Google Wallet and PayShare into its ordering process. Notably, the company is also the only pizza chain in the U.S. with an e-Commerce help desk, which has been extended to social channels as well. In fact, Domino's Pizza has gained significantly from the digital trend, with around 50% of its U.S. sales coming from digital platforms, at the end of 2015. The company is also updating its digital platforms constantly to better connect with guests.

Additionally, the world’s largest coffee shop operator, Starbucks Corp. (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.

Meanwhile, in order to capitalize on the increasing demand for their products, a few players in the industry like Panera Bread, BJ's Restaurants, Chipotle and Noodles & Company (NDLS - Free Report) are offering off-premise catering programs. These programs are especially designed to serve a large number of customers at their homes, offices or at any other venue.

Meanwhile, Starbucks has initiated a food and beverage delivery service through its employees at New York’s Empire State building last October. The company also began testing food and beverage delivery in collaboration with Postmates in select areas of Seattle last December.

Cost-Cutting Efforts: Given the exponential rise in costs, companies are striving to keep them under control. Through its Project Q initiatives, BJ's Restaurants is striving to reduce kitchen hours and enhance labor efficiencies. The Cheesecake Factory Inc. CAKE and Darden Restaurants, Inc. DRI are also working on techniques to aggressively cut costs. Meanwhile, Panera Bread has also rolled out its Panera 2.0 program to drive sales as well as earnings while lowering costs.

Franchise-Based Business Model: Of late, various companies in the restaurants space like Yum! Brands, Inc. (YUM - Free Report) , Domino's Pizza, 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 inflation than their peers.

Adapting to Changing Consumer Preference: The latest trend at the U.S. eateries is a healthy menu, as consumers are increasingly showing preference for fresh, organic, nutritious and low-calorie food. Rising health concerns and growing awareness about obesity and related diseases have led to the shift in consumer preference toward healthy and “good for you” products.

Starbucks and Panera are replacing all artificial flavors and colors used in their food items with natural alternatives. Meanwhile, Chipotle is well known for using genetically modified organism-free ingredients in its food items.

McDonald's Corp. (MCD - Free Report) has pledged to shift completely to cage-free eggs for roughly 16,000 restaurants in the U.S. and Canada over the next 10 years. Further, companies like Dunkin' Brands Group, Inc. DNKN, Wendy's and Panera Bread are shifting to cage-free eggs to appease health conscious guests.

Meanwhile, pizza chain Papa John’s does not use trans-fat or partially hydrogenated oils in its products. Papa John’s is the first national pizza brand to remove cellulose as an anti-caking agent from its mozzarella cheese. Except soft drinks, the company has removed all sources of artificial flavors and synthetic colors from its menu in 2016, which includes pizza ingredients, pizza toppings, dessert items and sauces.

Moving to the consumer side, Americans are showing a fondness for having breakfast at restaurants. Exclusive breakfast offerings such as coffee, sandwiches, pancakes and doughnuts 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 less waiting time.

In fact, the consumption of breakfasts and morning snacks, in- and away-from-home, is projected to grow by 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 the 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 the non-healthy items in their menus are falling out of favor.

Bottom Line

There are plenty of reasons to be optimistic about the restaurant industry’s near- to medium-term outlook. Though the industry has its share of pitfalls, effective sales initiatives undertaken by the companies should keep it going. We expect the industry to sustain the momentum going ahead, allowing investors to cash in on the bountiful opportunitiesin the space.

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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